nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒10‒03
twenty-two papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Endogenous Business Cycles in OLG Economies with Multiple Consumption Goods By Carine Nourry; Alain Venditti
  2. News about Aggregate Demand and the Business Cycle By Jang-Ting Guo; Anca-Ioana Sirbu; Mark Weder
  3. News Shocks and Business Cycles: Bridging the Gap from Different Methodologies By Gortz, Christoph; Tsoukalas, John D.
  4. Public Education and Social Security: A Political Economy Approach By Tetsuo Ono
  5. Employment, hours and optimal monetary policy By Maarten DOSSCHE; Vivien LEWIS; Céline POILLY
  6. Sectoral Composition of Government Spending and Macroeconomic (In)stability By Jang-Ting Guo; Juin-Jen Chang; Jhy-Yuan Shieh; Wei-Neng Wang
  7. Spillovers, capital ows and prudential regulation in small open economies By Paul Castillo; Cesar Carrera; Marco Ortiz; Hugo Vega
  8. Risky Linear Approximations By Alexander Mayer-Gohde; ; ;
  9. Sectoral Asymmetries in a Small Open Economy By S. Tolga Tiryaki
  10. Collaterals and Growth Cycles with Heterogeneous Agents By Stefano Bosi; Mohanad Ismaël; Alain Venditti
  11. Adaptive Learning and Labour Market Dynamics By Federico di Pace; Kaushik Mitra; Shoujian Zhang
  12. Increased longevity and social security reform : questioning the optimality of individual accounts when education matters By Gilles Le Garrec
  13. Land Collateral and Labor Market Dynamics in France By Leo Kaas; Patrick A. Pintus; Simon Ray
  14. Monetary Policy and Inflation Dynamics in Asset Price Bubbles By Daisuke Ikeda
  15. Precautionary Volatility and Asset Prices By Chen, Andrew Y.
  16. Exploiting the monthly data flow in structural forecasting By Giannone, Domenico; Monti , Francesca; Reichlin , Lucrezia
  17. Straightforward approximate stochastic equilibria for nonlinear rational expectations models By Michael K. Johnston; Robert G. King; Denny Lie
  18. Credit Status and College Investment: Implications for Student Loan Policies By Ionescu, Felicia; Simpson, Nicole B.
  19. Efficiency and Endogenous Fertility By Mikel Pérez-Nievas; J. Ignacio Conde-Ruiz; Eduardo L. Giménez
  20. Housing Dynamics over the Business Cycle By Finn E. Kydland; Peter Rupert; Roman Sustek
  21. Cross-country Transmission Effect of the U.S. Monetary Shock under Global Integration By Yoshiyuki Fukuda; Yuki Kimura; Nao Sudo; Hiroshi Ugai
  22. On the Optimality of U.S. Fiscal Policy: 1960-2010 By Salvador Ortigueira

  1. By: Carine Nourry (Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM, EHESS & Institut Universitaire de France); Alain Venditti (Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM, EHESS & EDHEC)
    Abstract: We consider an OLG economy with two consumption goods. There are two sectors that produce a pure consumption good and a mixed good which can be either consumed or used as capital. We prove that the existence of Pareto optimal expectations-driven fluctuations is compatible with standard sectoral technologies if the share of the pure consumption good is low enough. Following Reichlin's (1986, Journal of Economic Theory, 40, 89-102) influential conclusion, this result suggests that some fiscal policy rules can prevent the existence of business-cycle fluctuations in the economy by driving it to the optimal steady state as soon as it is announced.
    Keywords: Two-sector OLG model, multiple consumption goods, dynamic efficiency, Endogenous fluctuations, local indeterminacy
    JEL: C62 E32 O41
    Date: 2014–06
  2. By: Jang-Ting Guo (Department of Economics, University of California Riverside); Anca-Ioana Sirbu (Western Washington University); Mark Weder (University of Adelaide, Australia)
    Abstract: We examine the plausibility of expectations-driven cyclical fluctuations in an otherwise standard one-sector real business cycle model with variable capital utilization and mild increasing returns-to-scale in production. Due to a dominating wealth effect, our model is able to generate qualitatively as well as quantitatively realistic aggregate fluctuations driven by news impulses to future consumption demand or government spending on goods and services. When the economy is subject to anticipated total factor productivity or investment-specific technology shocks, the relative strength of the intertemporal substitution effect needs to be enhanced for our model to exhibit positive macroeconomic co-movement and business cycle statistics that are consistent with the data.
    Keywords: News Shocks; Aggregate Demand; Business Cycles.
    JEL: E32
    Date: 2014–09
  3. By: Gortz, Christoph; Tsoukalas, John D.
    Abstract: An important disconnect in the news driven view of the business cycle formalized by Beaudry and Portier (2004), is the lack of agreement between different—VAR and DSGE—methodologies over the empirical plausibility of this view. We argue that this disconnect can be largely resolved once we augment a standard DSGE model with a ï¬nancial channel that provides ampliï¬cation to news shocks. Both methodologies suggest news shocks to the future growth prospects of the economy to be signiï¬cant drivers of U.S. business cycles in the post-Greenspan era (1990-2011), explaining as much as 50% of the forecast error variance in hours worked in cyclical frequencies
    Keywords: News shocks, Business cycles, DSGE, VAR, Bayesian estimation,
    Date: 2013
  4. By: Tetsuo Ono (Graduate School of Economics, Osaka University)
    Abstract: This study presents an overlapping-generations model with altruism towards children. We characterize a Markov-perfect political equilibrium of voting over two policy issues, public education for the young and social security for the old. The model potentially generates two types of political equilibria, one favoring public education and the other favoring social security. One equilibrium is selected by the government to maximize its objective. It is shown that (i) longevity affects equilibrium selection and relevant policy choices; and (ii) private education as an alternative to public education and a Markov-perfect political equilibrium can gen- erate the two types of equilibria.
    Keywords: Public education; Social security; Intergenerational conflict
    JEL: H52 H55 I22
    Date: 2013–09
  5. By: Maarten DOSSCHE; Vivien LEWIS; Céline POILLY
    Abstract: We characterize optimal monetary policy in a New Keynesian search-and-matching model where multiple-worker firms satisfy demand in the short run by adjusting hours per worker. Imperfect product market competition and search frictions reduce steady state hours per worker below the efficient level. Bargaining results in a convex wage curve’ linking wages to hours. Since the steady-state real marginal wage is low, wages respond little to hours. As a result, firms overuse the hours margin at the expense of hiring, which makes hours too volatile. The Ramsey planner uses inflation as a instrument to dampen inefficient hours fluctuations.
    Date: 2014–06
  6. By: Jang-Ting Guo (Department of Economics, University of California Riverside); Juin-Jen Chang (Academia Sinica); Jhy-Yuan Shieh (Soochow University); Wei-Neng Wang (Soochow University)
    Abstract: This paper examines the quantitative interrelations between sectoral composition of public spending and equilibrium (in)determinacy in a two-sector real business cycle model with positive productive externalities in investment. When government purchases of con- sumption and investment goods are set as constant fractions of their respective sectoral output, we show that the public-consumption share plays no role in the modeliÌs local dynamics, and that a su¢ ciently high public-investment share can stabilize the economy against endogenous belief-driven cyclical aÌuctuations. When each type of government spending is postulated as a constant proportion of the economyiÌs total output, we Önd that there exists a trade-o§ between public consumption versus investment expenditures to yield saddle-path stability and equilibrium uniqueness.
    Keywords: Government Spending; Equilibrium (In)determinacy; Business Cycles
    JEL: E32 E62 O41
    Date: 2013–09
  7. By: Paul Castillo; Cesar Carrera; Marco Ortiz; Hugo Vega
    Abstract: This paper extends the model of Aoki et al. (2009) considering a two sector small open economy. We study the interaction of borrowing, asset prices, and spillovers between tradable and non-tradable sectors. Our results suggest that when it is difficult to enforce debtors to repay their debt unless it is secured by collateral, a productivity shock in the tradable sector generates an increase in asset prices and leverage that spills over to the non-tradable sector, generating an appreciation of the real exchange and an increase in domestic lending. Macro-prudential instruments are introduced under the form of cyclical loan-to-value ratios that limit the amount of capital that entrepreneurs can pledge as collateral. Cyclical taxes that respond to the movements in the price of non-tradable goods are analysed. Simulation results show that this type of instruments significantly lessen the amplifying effects of borrowing constraints on small open economies and consequently reduce output and asset price volatility.
    Keywords: Collateral, productivity, small open economy
    Date: 2014–09
  8. By: Alexander Mayer-Gohde; ; ;
    Abstract: I construct risk-corrected approximations of the policy functions of DSGEmodels around the stochastic steady state and ergodic mean that are linear in the state variables. The resulting approximations are uniformly more accurate than standard linear approximations and capture the dynamics of asset pricing variables such as the expected risk premium missed by standard linear approximations. The algorithm is fast and reliable, requiring only the solution of linear equations using standard perturbation output. I examine the joint macroeconomic and asset pricing implications of a real business cycle model with stochastic trends and recursive preferences. The method is able to estimate risk aversion under these preferences using the Kalman filter, where a standard linear approximation provides no information and alternative methods require computationally intensive particle filters subject to sampling variation.
    Keywords: DSGE; Solution methods; Ergodic mean; Stochastic steady state; Perturbation
    JEL: C61 C63 E17
    Date: 2014–07
  9. By: S. Tolga Tiryaki
    Abstract: This paper explores the sectoral dimension of emerging market business cycles by building a two-sector small open economy real business cycle model featuring a working capital requirement, variable capital utilization and imported inputs in production. The primary finding is that the price of imported inputs and nontradable sector productivity are the two most important sources of macroeconomic fluctuations in a typical emerging market economy. Interest rates and the price of imported final goods also play significant role in driving investment and import fluctuations. The model also produces significant sectoral asymmetry, especially in response to interest rate shocks. Variable capital utilization acts as a strong propagation mechanism.
    Keywords: Business cycles, Emerging markets, Imported inputs, Capital utilization
    JEL: E32 F32
    Date: 2014
  10. By: Stefano Bosi (EPEE - Université d'Evry-Val d'Essonne); Mohanad Ismaël (University of Birzeit - University of Birzeit); Alain Venditti (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), EDHEC Business School - Département Comptabilité, Droit, Finance et Economie)
    Abstract: We investigate the effects of collaterals and monetary policy on growth rate dynamics in a Ramsey economy where agents have heterogeneous discount factors. We focus on the existence of business-cycle fluctuations based on self-fulfilling prophecies and on the occurrence of deterministic cycles through bifurcations. We introduce liquidity constraints in segmented markets where impatient (poor) agents without collaterals have limited access to credit. We find that an expansionary monetary policy may promote economic growth while making endogenous fluctuations more likely. Conversely, a regulation reinforcing the role of collaterals and reducing the financial market imperfections may enhance the economic growth and stabilize the economy.
    Keywords: collaterals; heterogeneous agents; balanced growth; endogenous fluctuations; stabilization policies
    Date: 2014–02
  11. By: Federico di Pace (University of St Andrews); Kaushik Mitra (University of St Andrews); Shoujian Zhang (University of St Andrews)
    Abstract: It is well known that the standard search and matching model with Rational Expectations (RE) is unable to generate amplification in unemployment and vacancies. We show that relaxing the RE assumption has the potential to provide a solution to this well known unemployment volatility puzzle. A model in which agents use Recursive Least Square algorithms to update their expectations as new information becomes available is presented. Firms choose vacancies by making infinite horizon forecasts over (un)employment rates, wages and interest rates at each point in time. Firms have much greater incentive for vacancy posting because of overoptimism about the discounted value of expected profits at the time a positive TFP shock hits the economy. The model with adaptive learning is able to match the relative volatility of labour market variables in US data and the properties of forecast errors of unemployment rates obtained from the Survey of Professional Forecasters.
    Keywords: adaptive learning, bounded-rationality, search and matching frictions
    JEL: E24 E25 E32 J64
    Date: 2014–09–10
  12. By: Gilles Le Garrec (OFCE Sciences PO)
    Abstract: In many European countries, population aging had led to debate about a switch from conventional unfunded public pension systems to notional sys- tems characterized by individual accounts. In this article, we develop an overlapping generations model in which endogenous growth is based on an accumulation of knowledge driven by the proportion of skilled workers and by the time they have spent in training. In such a framework, we show that conventional pension systems, contrary to notional systems, can enhance eco- nomic growth by linking beneÖts only to the partial earnings history. Thus, to ensure economic growth, the optimal adjustment to increased longevity could consist in increasing the size of existing retirement systems rather than switching to national system
    Date: 2014–05
  13. By: Leo Kaas (UNiversity of Konstanz - University of Konstanz); Patrick A. Pintus (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)); Simon Ray (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), Centre de recherche de la Banque de France - Banque de France)
    Abstract: The value of land in the balance sheet of French firms correlates positively with their hiring and investment flows. To explore the relationship between these variables, we develop a macroeconomic model with firms that are subject to both credit and labor market frictions. The value of collateral is driven by the forward-looking dynamics of the land price, which reacts endogenously to fundamental and non-fundamental (sunspot) shocks. We calibrate the model to French data and find that land price shocks give rise to significant amplification and hump-shaped responses of investment, vacancies and unemployment that are in line with the data.
    Keywords: financial shocks; labor market frictions
    Date: 2014–09
  14. By: Daisuke Ikeda (Bank of Japan)
    Abstract: This paper integrates an asset price bubble and agency costs in firms' price-setting decisions into a monetary DSGE framework. Amplified by nominal wage rigidities, an asset price bubble causes an inefficiently excessive boom. Inflation, however, remains moderate in the boom, because a loosening in financial tightness lowers the agency costs and adds downward pressure on inflation. Stabilizing inflation makes the excessive boom even excessive in the short run. The optimal monetary policy calls for monetary tightening to restrain the boom at the cost of greater volatility in inflation.
    Keywords: Optimal monetary policy; Asset price bubbles
    JEL: E44 E52
    Date: 2013–02–28
  15. By: Chen, Andrew Y. (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Many theories of asset prices assume time-varying uncertainty in order to generate time-varying risk premia. This paper generates time-varying uncertainty endogenously, through precautionary saving dynamics. Precautionary motives prescribe that, in bad times, next period's consumption should be very sensitive to news. This time-varying sensitivity results in time-varying consumption volatility. Production makes this channel visible, and external habit preferences amplify it. An estimated model featuring this channel quantitatively accounts for excess return and dividend predictability regressions. It also matches the first two moments of excess equity returns, the risk-free rate, and the second moments of consumption, output, and investment.
    Keywords: Time-varying risk premia; the equity premium puzzle; time-varying volatility; habit; precautionary savings
    Date: 2014–08–12
  16. By: Giannone, Domenico (LUISS and Centre for Economic Policy Research); Monti , Francesca (Bank of England); Reichlin , Lucrezia (London Business School and Centre for Economic Policy Research)
    Abstract: This paper shows how and when it is possible to obtain a mapping from a quarterly dynamic stochastic general equilibrium (DSGE) model to a monthly specification that maintains the same economic restrictions and has real coefficients. We use this technique to derive the monthly counterpart of the well-known DSGE model by Galí, Smets and Wouters (GSW) for the US economy. We then augment it with auxiliary macro indicators which, because of their timeliness, can be used to obtain a nowcast of the structural model. We show empirical results for the quarterly growth rate of GDP, the monthly unemployment rate and GSW’s welfare-relevant output gap. Results show that the augmented monthly model does best for nowcasting.
    Keywords: Forecasting; temporal aggregation; mixed frequency data; large data sets
    JEL: C33 C53 E30
    Date: 2014–09–12
  17. By: Michael K. Johnston; Robert G. King; Denny Lie
    Abstract: We present a new approach to the approximation of equilibrium solutions to nonlinear rational expectations models that applies to any order of approximation. The approach relies on a particular version of Taylor series approximations - the differential version - and on a scalar perturbation of the support of the entire history of shocks. The resulting solution for any order can always be directly cast in a linear state-space form, permitting the solution to be used for many practical applications such as forecasting, estimation, and computing impulse responses. Using the approach, we show that there cannot be multiple solutions in any order of approximation if the associated first-order approximate solution is determinate. Our approach can be used simply to verify key propositions of the earlier literature, to extend its range of applications, and to resolve puzzles left by it. While the paper only provides an explicit solution up to a third-order approximation, extensions to any higher order approximations are straightforward.
    Keywords: Solution methods, higher order approximations, perturbation, differential Taylor series approximation, nonlinear rational expectations models, pruning, DSGE
    JEL: C63 C68 E17 E37
    Date: 2014–09
  18. By: Ionescu, Felicia (Board of Governors of the Federal Reserve System (U.S.)); Simpson, Nicole B. (Colgate University)
    Abstract: The private market for student loans has become an important source of college financing in the United States. Unlike government student loans, the terms on student loans in the private market are based on credit status. We quantify the importance of the private market for student loans and of credit status for college investment in a general equilibrium heterogeneous life-cycle economy. We find that students with good credit status invest in more college education (compared to those with bad credit status) and that this effect is more pronounced for low-income students. Furthermore, results suggest that the relationship between credit status and college investment has important policy implications. Specifically, when borrowing limits in the government student loan program are relaxed (as implemented in 2008), college investment increases, but so does the riskiness of the pool of borrowers, leading to higher default rates in the private market for student loans. When general equilibrium effects are accounted for, the welfare gains experienced from a more generous government student loan program are negated. This compares to budget-neutral tuition subsidies that increase college investment and welfare.
    Keywords: College investment; credit status; student loans; default
    JEL: D53 E21 J22 J28
    Date: 2014–08–26
  19. By: Mikel Pérez-Nievas; J. Ignacio Conde-Ruiz; Eduardo L. Giménez
    Abstract: This paper explores the properties of several notions of efficiency (A−efficiency, P−efficiency and Millian efficiency) to evaluate allocations in a general overlapping generations setting with endogenous fertility and descendant altruism that includes, as a particular case, Barro and Becker’s (1988) model of fertility choice. We first focus on the notion of A−efficiency, proposed by Golosov, Jones and Tertilt (Econometrica, 2007) and show that, in many environments, the set of symmetric, interior, A−efficient allocations is empty. To overcome this problem, we then propose to evaluate the efficiency of a given allocation with a particular specification of P−efficiency –proposed also by Golosov et al.– for which the utility attributed to the unborn depends on the utility level achieved by those who get to be born in a given allocation. For a large class of specifications of the function determining the utility attributed to the unborn, every Millian efficient allocation, that is, every symmetric allocation that is not A−dominated by any other symmetric allocation, is also P-efficient. Finally, we restate the First Welfare Theorem by showing that a) every competitive equilibrium is a –statically– Millian efficient allocation; and that b) if long-run wages do not exceed the capitalized costs of rearing children, then competitive equilibria are also –dynamically– Millian efficient.
    Date: 2014–09
  20. By: Finn E. Kydland (Department of Economics, University of California-Santa Barbara (UCSB); National Bureau of Economic Research (NBER)); Peter Rupert (Department of Economics, University of California-Santa Barbara (UCSB)); Roman Sustek (School of Economics and Finance Queen Mary; Centre for Macroeconomics (CFM))
    Abstract: Housing construction, measured by housing starts, leads GDP in a number of countries. Measured as residential investment, the lead is observed only in the US and Canada; elsewhere, residential investment is coincident. Variants of existing theory, however, predict housing construction lagging GDP. In all countries in the sample, nominal interest rates are low ahead of GDP peaks. Introducing fully-amortizing mortgages and an estimated process for nominal interest rates into a standard model aligns the theory with the observations on starts; one-period loans are insu±cient to generate the lead. Longer time to build then makes residential investment cyclically coincident.
    Keywords: Residential investment, housing starts, business cycle, mortgage costs, time to build
    JEL: E22 E32 R21 R31
    Date: 2014–08
  21. By: Yoshiyuki Fukuda (Bank of Japan); Yuki Kimura (Bank of Japan); Nao Sudo (Bank of Japan); Hiroshi Ugai (Bank of Japan)
    Abstract: Monetary policy shocks in the United States are considered a significant cause of economic fluctuations in other countries. We study empirically how the spillover effects of such shocks have changed as a result of the recent deepening of global integration. We consider shocks to the Federal Funds rate and examine how domestic production in a number of advanced, Latin American, and Asian countries were affected by these shocks during the 1990s and 2000s. We show that contractionary U.S. monetary policy shocks reduced domestic production in most of the sampled countries during the 1990s. During the 2000s, by contrast, the adverse effects were moderated. To explore the reasons behind the weakened spillover effects, we construct a DSGE model and examine the theoretical implications of the recent changes in economic structure, including global integration. In addition, we estimate response of trade and financial variables as well as policy instruments to U.S. monetary policy shocks. Our model combined with the empirical exercises suggests that, despite being enhanced by deepened trade integration, spillover effects may be decreasing due to a decline in the relative importance of the U.S. economy, and to regime switches in domestic monetary and exchange rate policy in non-U.S. countries. Though we empirically find a sign of short-run financial contagion during the 2000s, its effect upon the real economy was minor, possibly reflecting its low persistence.
    Keywords: U.S. Monetary Policy; Spillover Effect; Financial and Trade Linkages
    Date: 2013–11–26
  22. By: Salvador Ortigueira
    Abstract: This paper assesses the optimality of U.S. fiscal policy from 1960 to 2010. With this purpose, we present a tractable neoclassical economy with a benevolent government and characterize time-consistent, optimal fiscal policy. We then compare the model's prescriptions for income tax rates and government expenditure with their empirical counterparts observed in the U.S. in this period. We find that U.S. income taxation and government consumption expenditure were in line with the model's prescriptions from 1960 to 2000. However, starting in the early 2000s and for the rest of the decade, U.S. fiscal policy trended in a direction opposite to that of the optimal policy prescribed by the model. In particular, U.S. income tax rates declined below their optimal rates, and government consumption expenditures as a share of GDP sharply increased above their optimal levels. By way of example, while our model prescribes a 10% reduction in the government consumption expenditure-to-GDP ratio between 2001 and 2010, the U.S. ratio increased by 23% in this period.
    Keywords: U.S. fiscal policy, Optimal fiscal policy
    JEL: E62 H24 H40 H50
    Date: 2014–08

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