nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2014‒11‒07
29 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Why the split of payroll taxation between firms and workers matters for macroeconomic stability By Simon Voigts; ; ;
  2. Dynamic prediction pools: an investigation of financial frictions and forecasting performance By Del Negro, Marco; Hasegawa, Raiden B.; Schorfheide, Frank
  3. Limited Asset Market Participation and the Optimal Fiscal and Monetary Policies By Lorenzo Menna; Patrizio Tirelli
  4. Labor Market Reforms and Current Account Imbalances - Beggar-thy-Neighbor Policies in a Currency Union? By Timo Baas; Ansgar Belke
  5. Money in the Production Function By Jonathan Benchimol
  6. High Marginal Tax Rates on the Top 1%? Lessons from a Life Cycle Model with Idiosyncratic Income Risk By Fabian Kindermann; Dirk Krueger
  7. Uncertainty, Financial Frictions, and Investment Dynamics By Gilchrist, Simon; Sim, Jae W.; Zakrajsek, Egon
  8. Estimating Dynamic Equilibrium Models with Stochastic Volatility By Jesús Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez
  9. Robust Dynamic Optimal Taxation and Environmental Externalities By Li, Xin; Narajabad, Borghan N.; Temzelides, Theodosios
  10. Financial News, Banks and Business Cycles By Alok Johri; Christopher M. Gunn
  11. Sectoral Interdependence and Business Cycle Synchronization in Small Open Economies By Drago Bergholt; Tommy Sveen
  12. Sentiment and the US Business Cycle By Fabio Milani
  13. Financial Conditions and Slow Recoveries By Kevin x.d. Huang; Jie Chen; Zhe Li; Jianfei Sun
  14. Monetary Policy in Oil Exporting Economies By Drago Bergholt
  15. Macroeconomic Dynamics Near the ZLB: A Tale of Two Countries By S. Borağan Aruoba; Pablo Cuba-Borda; Frank Schorfheide
  16. Fiscal Consolidations: Can We Reap the Gain and Escape the Pain? By Maria Ferrara; Patrizio Tirelli
  17. Choosing the variables to estimate singular DSGE models: Comment By Nikolay, Iskrev
  18. Utility functions, fiscal shocks and the open economy - In the search of a positive consumption multiplier By Philipp Wegmueller
  19. Efficient risk sharing with limited commitment and storage By Abraham, Arpad; Laczo, Sarolta
  20. Taxing Top Earners: A Human Capital Perspective By Mark Huggett; Alejandro Badel
  21. How important is variability in consumer credit limits? By Fulford, Scott L.
  22. Optimal progressive taxation in a model with endogenous skill supply By Stylianos Asimakopoulos; James Malley; Konstantinos Angelopoulos
  23. Solving asset pricing models with stochastic volatility By de Groot, Oliver
  24. The Macroeconomic Effects of Fiscal Consolidation in Dynamic General Equilibrium By Tim Schwarzmüller; Maik Wolters
  25. Infrequent fiscal stabilization By Yuting Bai; Tatiana Kirsanova
  26. Rural-Urban Migration, Structural Transformation, and Housing Markets in China By Garriga, Carlos; Tang, Yang; Wang, Ping
  27. RHOMOLO: A Dynamic Spatial General Equilibrium Model for Assessing the Impact of Cohesion Policy By Andries Brandsma; d'Artis Kancs; Philippe Monfort; Alexandra Rillaers
  28. Reforming the U.S. Social Security system accounting for employment uncertainty By Hugo Benítez-Silva; J. Ignacio García-Pérez; Sergi Jiménez-Martín
  29. Shopping Time By Nicolas Petrovsky-Nadeau; Etienne Wasmer; Shutian Zeng

  1. By: Simon Voigts; ; ;
    Abstract: Conventional wisdom states that the statutory split of payroll taxa- tion between rms and workers is of no macroeconomic relevance, because the tax incidence is fully determined by the market structure. This pa- per breaks with this view by establishing a theoretical link between the statutory split and the average volatility of prices and wages. It is shown that shifting taxation towards workers signicantly reduces the volatility in nominal variables without entailing long-run redistribution. The gain in stability of prices and wages reduces ineciencies in the equilibrium allocation of the stochastic model and thereby reduces welfare costs of business cycle uctuations. In a standard DSGE model, welfare costs un- der the full taxation of rms are 11.25% larger than under the full taxation of workers.
    Keywords: Payroll taxes, social security, business cycles, automatic stabilizers, optimal taxation
    JEL: H55 H21 E30 E32 E60
    Date: 2014–10
  2. By: Del Negro, Marco (Federal Reserve Bank of New York); Hasegawa, Raiden B.; Schorfheide, Frank
    Abstract: We provide a novel methodology for estimating time-varying weights in linear prediction pools, which we call dynamic pools, and use it to investigate the relative forecasting performance of dynamic stochastic general equilibrium (DSGE) models, with and without financial frictions, for output growth and inflation in the period 1992 to 2011. We find strong evidence of time variation in the pool’s weights, reflecting the fact that the DSGE model with financial frictions produces superior forecasts in periods of financial distress but doesn’t perform as well in tranquil periods. The dynamic pool’s weights react in a timely fashion to changes in the environment, leading to real-time forecast improvements relative to other methods of density forecast combination, such as Bayesian model averaging, optimal (static) pools, and equal weights. We show how a policymaker dealing with model uncertainty could have used a dynamic pool to perform a counterfactual exercise (responding to the gap in labor market conditions) in the immediate aftermath of the Lehman crisis.
    Keywords: Bayesian estimation; DSGE models; financial frictions; forecasting; Great Recession; linear prediction pools
    JEL: C53 E31 E32 E37
    Date: 2014–10–01
  3. By: Lorenzo Menna; Patrizio Tirelli
    Abstract: In the workhorse DSGE model, the optimal steady state inflation rate is near to zero or slightly negative and inflation is almost completely stabilized along the business cycle (Schmitt-Grohè and Uribe, 2011). We reconsider the issue, allowing for agent heterogeneity in the access to the market for interest bearing assets. We show that inflation reduces inequality and that LAMP can justify relatively high optimal inflation rates. When we calibrate the share of constrained agents to fit the wealth Gini index for the US, the optimal inflation rate is well above 2%. The optimal response to shocks is also a¤ected. Rather than using public debt to smooth tax distortions, the Ramsey planner front loads tax rates and reduces public debt variations in order to limit the redistributive e¤ects of debt service payments.
    Keywords: trend in�ation, monetary and �scal policy, Ramsey plan, Limited Asset Market Participation.
    JEL: E52 E58 J51 E24
    Date: 2014–10
  4. By: Timo Baas; Ansgar Belke
    Abstract: Member countries of the European Monetary Union (EMU) initiated wideranging labor market reforms in the last decade. This process is ongoing as countries that are faced with serious labor market imbalances perceive reforms as the fastest way to restore competitiveness within a currency union. This fosters fears among observers about a beggar-thy-neighbor policy that leaves non-reforming countries with a loss in competitiveness and an increase in foreign debt. Using a two-country, two-sector search and matching DSGE model, we analyze the impact of labor market reforms on the transmission of macroeconomic shocks in both, non-reforming and reforming countries. By analyzing the impact of reforms on foreign debt, we contribute to the debate on whether labor market reforms increase or reduce current account imbalances.
    Keywords: Current account deficit; labor market reforms; DSGE models; search and matching labor market
    JEL: E24 E32 J64 F32
    Date: 2014–09
  5. By: Jonathan Benchimol (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, PhD Program - ESSEC Business School)
    Abstract: This paper proposes a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model where real money balances enter the production function. By using a Bayesian analysis, our model shows that money is not an omitted input to the production process and rejects the decreasing returns to scale hypothesis. Our simulations suggest that money plays a negligible role in the dynamics of output and inflation, despite its inclusion in the production function. In addition, we introduce the flexible-price real money balances concept.
    Keywords: Money in the production function; DSGE; Bayesian estimation.
    Date: 2013–02–01
  6. By: Fabian Kindermann (Institute for Macroeconomics and Econometrics, University of Bonn); Dirk Krueger (Department of Economics, University of Pennsylvania)
    Abstract: n this paper we argue that very high marginal labor income tax rates are an effective tool for social insurance even when households have preferences with high labor supply elasticity, make dynamic savings decisions, and policies have general equilibrium effects. To make this point we construct a large scale Overlapping Generations Model with uninsurable labor productivity risk, show that it has a wealth distribution that matches the data well, and then use it to characterize fiscal policies that achieve a desired degree of redistribution in society. We find that marginal tax rates on the top 1% of the earnings distribution of close to 90% are optimal. We document that this result is robust to plausible variation in the labor supply elasticity and holds regardless of whether social welfare is measured at the steady state only or includes transitional generations.
    Keywords: Progressive Taxation, Top 1%, Social Insurance, Income Inequality
    JEL: E62 H21 H24
    Date: 2024–10–10
  7. By: Gilchrist, Simon (Boston University); Sim, Jae W. (Board of Governors of the Federal Reserve System (U.S.)); Zakrajsek, Egon (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: Micro- and macro-level evidence indicates that fluctuations in idiosyncratic uncertainty have a large effect on investment; the impact of uncertainty on investment occurs primarily through changes in credit spreads; and innovations in credit spreads have a strong effect on investment, irrespective of the level of uncertainty. These findings raise a question regarding the economic significance of the traditional "wait-and-see" effect of uncertainty shocks and point to financial distortions as the main mechanism through which fluctuations in uncertainty affect macroeconomic outcomes. The relative importance of these two mechanisms is analyzed within a quantitative general equilibrium model, featuring heterogeneous firms that face time-varying idiosyncratic uncertainty, irreversibility, nonconvex capital adjustment costs, and financial frictions. The model successfully replicates the stylized facts concerning the macroeconomic implications of uncertainty and financial shocks. By influencing the effective supply of credit, both types of shocks exert a powerful effect on investment and generate countercyclical credit spreads and procyclical leverage, dynamics consistent with the data and counter to those implied by the technology-driven real business cycle models.
    Keywords: Time-varying volatility; asset specificity; capital liquidity shocks; costly external finance; firm heterogeneity; general equilibrium
    JEL: E22 E32 G31
    Date: 2014–04–01
  8. By: Jesús Fernández-Villaverde; Pablo Guerrón-Quintana; Juan F. Rubio-Ramírez
    Abstract: This paper develops a particle filtering algorithm to estimate dynamic equilibrium models with stochastic volatility using a likelihood-based approach. The algorithm, which exploits the structure and profusion of shocks in stochastic volatility models, is versatile and computationally tractable even in large-scale models. As an application, we use our algorithm and Bayesian methods to estimate a business cycle model of the U.S. economy with both stochastic volatility and parameter drifting in monetary policy. Our application shows the importance of stochastic volatility in accounting for the dynamics of the data.
    Date: 2014–10
  9. By: Li, Xin (International Monetary Fund); Narajabad, Borghan N. (Board of Governors of the Federal Reserve System (U.S.)); Temzelides, Theodosios (Rice University)
    Abstract: We study a dynamic stochastic general equilibrium model in which agents are concerned about model uncertainty regarding climate change. An externality from greenhouse gas emissions damages the economy's capital stock. We assume that the mapping from climate change to damages is subject to uncertainty, and we use robust control theory techniques to study efficiency and optimal policy. We obtain a sharp analytical solution for the implied environmental externality and characterize dynamic optimal taxation. A small increase in the concern about model uncertainty can cause a significant drop in optimal fossil fuel use. The optimal tax that restores the socially optimal allocation is Pigouvian. Under more general assumptions, we develop a recursive method and solve the model computationally. We find that the introduction of uncertainty matters qualitatively and quantitatively. We study optimal output growth in the presence and in the absence of concerns about uncertainty and find that these concerns can lead to substantially different conclusions.
    Keywords: Climate change; optimal dynamic taxation; uncertainty; robust
    Date: 2014–05–29
  10. By: Alok Johri; Christopher M. Gunn
    Abstract: Can variations in the expected future return on a portfolio of sovereign bonds itself have real effects on a small open economy? We build a model where banks face a capital sufficiency requirement to demonstrate that news about a fall in the expected return on a portfolio of long bonds can lead to an immediate recession. Even if the news never materializes, the model can generate a severe recession followed by a slow recovery. The presence of long bonds in bank portfolios causes the news to have an immediate impact on bank capital via an immediate fall in bond prices. The portfolio adjustment induced by the capital sufficiency requirements leads to a rise in loan rates while aggregate output, investment and employment collapse. The model contributes to the news-shock literature by showing that imperfect signals about future financial returns can create business cycles without relying on the usual suspects: variation in domestic fundamentals such as technology shocks, preference shocks and fiscal policy. It also contributes to the emerging economy business cycle literature in that disturbances in world financial markets can lead to domestic business cycles without relying on shocks to the world interest rate or to country spreads.
    Keywords: expectations-driven business cycles, news shocks, financial intermediation, business cycles, small open economy, capital adequacy requirements
    JEL: E3 E44 F4 G21
    Date: 2014–10
  11. By: Drago Bergholt; Tommy Sveen
    Abstract: Existing DSGE models are not able to reproduce the observed influence of international business cycles on small open economies. We construct a two-sector New Keynesian model to address this puzzle. The set-up takes into account intermediate trade and producer heterogeneity, where goods and service industries differ in terms of i) price flexibility, ii) trade intensity, iii) technology, iv) I-O structure, and v) the volatility of productivity innovations. The combination of intermediate markets and heterogeneous producers makes international business cycles highly important for the small economy, even if it has a large service sector. Exploiting I-O matrices of Canadian and US industries, the model is able to reproduce the role of international disturbances typically found in empirical studies. Model simulations deliver cross-country correlations in macroeconomic variables of about 0.7, with half of the variation in domestic variables attributed to foreign shocks.
    Keywords: small open economy, multi-sector, international trade, international business cycle
    JEL: E32 F41 F44
    Date: 2014
  12. By: Fabio Milani (Department of Economics, University of California-Irvine)
    Abstract: Psychological factors are commonly believed to play a role on cyclical economic fluctuations, but they are typically omitted from state-of-the-art macroeconomic models. This paper introduces “sentiment†in a medium-scale DSGE model of the U.S. economy and tests the empirical contribution of sentiment shocks to business cycle fluctuations. The assumption of rational expectations is relaxed. The paper exploits, instead, observed data on expectations in the estimation. The observed expectations are assumed to be formed from a near-rational learning model. Agents are endowed with a perceived law of motion that resembles the model solution under rational expectations, but they lack knowledge about the solution’s reduced- form coefficients. They attempt to learn those coefficients over time using available time series at each point in the sample and updating their beliefs through constant-gain learning. In each period, however, they may form expectations that fall above or below those implied by the learning model. These deviations capture excesses of optimism and pessimism, which can be quite persistent and which are defined as sentiment in the model. Different sentiment shocks are identified in the empirical analysis: waves of undue optimism and pessimism may refer to expected future consumption, future investment, or future inflationary pressures. The results show that exogenous variations in sentiment are responsible for a sizable (above forty percent) portion of historical U.S. business cycle fluctuations. Sentiment shocks related to investment decisions, which evoke Keynes’ animal spirits, play the largest role. When the model is estimated imposing the rational expectations hypothesis, instead, the role of structural investment- specific and neutral technology shocks significantly expands to capture the omitted contribution of sentiment.
    Keywords: Sentiment; Animal spirits; Learning; DSGE model; Sources of business cycle fluctuations; Observed survey Expectations
    JEL: E31 E32 E50 E52 E58 F41
    Date: 2014–09
  13. By: Kevin x.d. Huang (Vanderbilt University); Jie Chen (Shanghai University of Finance and Economics); Zhe Li (Shanghai University of Finance and Economics); Jianfei Sun (Shanghai Jiao Tong University)
    Abstract: We argue that financial frictions and financial shocks can be an important factor behind the slow recoveries from the three most recent recessions. To illustrate this point, we augment a simple RBC model with a collateral constraint whose tightness is randomly disturbed by a shock that prescribes the general financial condition in the economy. We present evidence that such financial shock has become more persistent since the mid 1980s. We show that this can be an important contributor to the recent slow recoveries, and that a main mechanism may have to do with just-in-time-uses of capital and labor in the face of tight credit conditions during the recoveries. To assess the importance of such financial shock relative to other shocks in contributing to the slow recoveries, we enrich a New Keynesian model, which features various structural shocks and frictions widely considered in the literature, with the financial frictions and financial shocks studied in our parsimonious model. Our structural estimates of this comprehensive model indicate that financial shocks can play a dominant role in accounting for the slow recoveries, especially in employment growth rate.
    Keywords: Collateral constraint; Financial shock; Slow recovery; Capital shortage; Extensive margin; Intensive margin
    JEL: E2 E3
    Date: 2014–06–06
  14. By: Drago Bergholt
    Abstract: How should monetary policy be constructed when national income depends on oil exports? I set up a general equilibrium model for an oil exporting small open economy to analyze this question. Fundamentals include an oil sector and domestic non-oil firms – some of which are linked to oil markets via supply chains. In the model, the intermediate production network implies transmission of international oil shocks to all domestic industries. The presence of wage and price rigidities at the sector level leads to non-trivial trade-offs between different stabilization tar- gets. I characterize Ramsey-optimal monetary policy in this environment, and use the framework to shed light on i) welfare implications of the supply chain channel, and ii) costs of alternative policy rules. Three results emerge: First, optimal policy puts high weight on nominal wage stability. In contrast, attempts to target impulses from the oil sector can be disastrous for welfare. Second, while oil sector activities contribute to macroeconomic fluctuations, they do not change the nature of optimal policy. Third, operational Taylor rules with high interest rate inertia can approximate the Ramsey equilibrium reasonably well.
    Keywords: Monetary policy, oil exports, small open economy, Ramsey equilibrium, DSGE
    JEL: E52 F41 Q33 Q43
    Date: 2014–07
  15. By: S. Borağan Aruoba (Department of Economics, University of Maryland); Pablo Cuba-Borda (Department of Economics, University of Maryland); Frank Schorfheide (Department of Economics, University of Pennsylvania)
    Abstract: We propose and solve a small-scale New-Keynesian model with Markov sunspot shocks that move the economy between a targeted-inflation regime and a deflation regime and fit it to data from the U.S. and Japan. For the U.S. we find that adverse demand shocks have moved the economy to the zero lower bound (ZLB) in 2009 and an expansive monetary policy has kept it there subsequently. In contrast, Japan has experienced a switch to the deflation regime in 1999 and remained there since then, except for a short period. The two scenarios have drastically different implications for macroeconomic policies. Fiscal multipliers are about 20% smaller in the deflationary regime, despite the economy remaining at the ZLB. While a commitment by the central bank to keep rates near the ZLB doubles the fiscal multipliers in the targeted-inflation regime (U.S.), it has no effect in the deflation regime (Japan).
    Keywords: DSGE Models, Government Spending Multiplier, Japan, Multiple Equilibria, Nonlinear Filtering, Nonlinear Solution Methods, Sunspots, U.S., ZLB
    JEL: C5 E4 E5
    Date: 2012–09–10
  16. By: Maria Ferrara; Patrizio Tirelli
    Abstract: Under limited asset market participation fiscal consolidations have a deep and prolonged deflationary effect, causing substantial short term welfare losses to households whose access to financial markets is limited. We show that it is possible to both reduce public debt and boost consumption of constrained households. This is obtained by allowing taxes to immediately undershoot their post-consolidation steady-state values. A similar result is achieved if temporary public transfers to constrained households are exploited to stimulate demand. We also find that an interest rate rule which reacts not only to inflation but also to the output gap is an effective complement to fiscal policy as a stabilization tool. In fact, the output gap target induces the Central Bank to implement a stronger interest rate cut which triggers a surge in the consumption of Ricardian households. This, in turn, has beneficial effects on labor incomes and on RT households' consumption. We obtain the apparently paradoxical result that such a policy allows to obtain better control of inflation, limiting deflationary pressures.
    Keywords: Fiscal Consolidation, DSGE modelling, Rule of Thumb Con- sumers, Fiscal Policy, Monetary Policy, Zero Lower Bound
    JEL: E32 E62 E63
    Date: 2014–10
  17. By: Nikolay, Iskrev
    Abstract: In a recent article Canova et al. (2014) study the optimal choice of variables to use in the estimation of a simplified version of the Smets and Wouters (2007) model. In this comment I examine their conclusions by applying a different methodology to the same model. The results call into question most of Canova et al. (2014) findings.
    Keywords: DSGE models, Observables, Identification, Information matrix, Cramer-Rao lower bound
    JEL: C32 C51 C52 E32
    Date: 2014–10
  18. By: Philipp Wegmueller
    Abstract: This paper analyzes the dynamic effects of a fiscal policy shock and its transmission mechanism in a small open economy and compares the responses under different specifications of the utility function. The traditional Mundell-Flemming model tells that fiscal policy is more effective under a peg than under a float. This result is not confirmed for a baseline small open economy model with separable preferences. The present paper offers a survey of non-separable utility found in the literature on fiscal policy shocks and compares their implications for the transmission mechanism. The aim is to overturn the negative wealth effect of an increase in government spending, which causes a decrease in private consumption under the baseline separable utility function. Using a plausible calibration of the model, I find that if the complementarity between consumption and hours worked is large enough, then the response of private consumption is likely to be positive, although the assumptions have to be strong. This result holds for any specification of exchange rate regime.
    Keywords: Fiscal Shocks; Non-Separable Utility; Exchange Rate Regimes; Private Consumption
    JEL: E52 E62 F41
    Date: 2014–10
  19. By: Abraham, Arpad; Laczo, Sarolta
    Abstract: We extend the model of risk sharing with limited commitment (Kocherlakota, 1996) by introducing both a public and a private (non-contractible and/or non-observable) storage technology. Positive public storage relaxes future participation constraints and may hence improve risk sharing, contrary to the case where hidden income or effort is the deep friction. The characteristics of constrained-efficient allocations crucially depend on the storage technology’s return. In the long run, if the return on storage is (i) moderately high, both assets and the consumption distribution may remain time-varying; (ii) sufficiently high, assets converge almost surely to a constant and the consumption distribution is time-invariant; (iii) equal to agents’ discount rate, perfect risk sharing is self-enforcing. Agents never have an incentive to use their private storage technology, i.e., Euler inequalities are always satisfied, at the constrained-efficient allocation of our model, while this is not the case without optimal public asset accumulation.
    Keywords: Risk sharing, Limited commitment, Hidden storage, Dynamic contracts
    JEL: E20
    Date: 2014
  20. By: Mark Huggett (Department of Economics, Georgetown University); Alejandro Badel (Research Division, Federal Reserve Bank of St. Louis)
    Abstract: We assess the consequences of substantially increasing the marginal tax rate on U.S. top earners using a human capital model. The top of the model Laffer curve occurs at a 53 percent top tax rate. Tax revenues and the tax rate at the top of the Laffer curve are smaller compared to an otherwise similar model that ignores the possibility of skill change in response to a tax reform. We also show that if one applies the methods used by Diamond and Saez (2011) to provide quantitative guidance for setting the tax rate on top earners to model data then the resulting tax rate exceeds the tax rate at the top of the model Laffer curve.
    Keywords: Human Capital, Marginal Tax Rates, Inequality, Laffer Curve
    JEL: D91 E21 H2 J24
    Date: 2014–07–23
  21. By: Fulford, Scott L. (Boston College)
    Abstract: Credit limit variability is a crucial aspect of the consumption, savings, and debt decisions of households in the United States. Using a large panel, this paper first demonstrates that individuals gain and lose access to credit frequently and often have their credit limits reduced unexpectedly. Credit limit volatility is larger than most estimates of income volatility and varies over the business cycle. While typical models of intertemporal consumption fix the credit limit, I introduce a model with variable credit limits. Variable credit limits create a reason for households to hold both high interest debts and low interest savings at the same time, since the savings act as insurance. Simulating the model using the estimates of credit limit volatility, I show that it explains all of the credit card puzzle: why around a third of households in the United States hold both debt and liquid savings at the same time. The approach also offers an important new channel through which financial system uncertainty affects household decisions.
    Keywords: credit card puzzle; intertemporal consumption; precaution; credit limits; household finance
    JEL: D14 D91 E21
    Date: 2010–06–01
  22. By: Stylianos Asimakopoulos; James Malley; Konstantinos Angelopoulos
    Abstract: This paper examines quantitatively the extent of progressivity or regressivity of optimal labour income taxation in a model with skill heterogeneity, endogenous skill acquisition and a production sector with capital-skill complementarity. We Â…find that wage inequality driven by the resource requirements of skill-creation implies progressive labour income taxation in the steady-state as well as along the transition path from the exogenous to optimal policy steady-state. In particular, in the steady state, skilled labour income is taxed about 40% more than unskilled labour income. We further Â…nd that these results are explained by a lower work time elasticity for skilled versus unskilled labour which results from the introduction of the skill acquisition technology.
    Keywords: optimal progressive taxation, skill premium, allocative efficiency
    Date: 2014
  23. By: de Groot, Oliver (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: This paper provides a closed-form solution for the price-dividend ratio in a standard asset pricing model with stochastic volatility. The solution is useful in allowing comparisons among numerical methods used to approximate the non-trivial closed-form.
    Keywords: Endowment model; price-dividend ratio; closed-form solution
    JEL: C61 C62 G12
    Date: 2014–08–27
  24. By: Tim Schwarzmüller; Maik Wolters
    Abstract: We provide a systematic analysis of fiscal consolidation in a medium-scale dynamic general equilibrium model. Our results show that the choice of the consolidation instrument is very important, not only with respect to the short- and long-run output effects of the different consolidation strategies, but also regarding the welfare effects and the distributional consequences. Moreover, we show that these aspects become even more important if fiscal consolidation has to be conducted at a binding zero lower bound on nominal interest rates because in this case the negative short-run output costs increase. Our comprehensive analysis of the transmission channels of various fiscal consolidation measures shows that in particular the presence of credit-constrained households who cannot smooth consumption has a large impact on the overall output and welfare effects of fiscal consolidation. Further, it turns out to be important whether a fiscal instrument directly affects private production factors negatively as it is the case for consolidation via government investment and taxes on labor and capital. In these cases the short-run output contraction is large and persistent because either the private or the public capital stock decreases. By contrast, for a consolidation via government consumption, transfers or the consumption tax rate, output recovers much faster
    Keywords: fiscal consolidation, government debt, distortionary taxes, zero lower bound, welfare, monetary-fiscal policy interaction
    JEL: E32 E62 E63 H61 H62 H63
    Date: 2014–09
  25. By: Yuting Bai; Tatiana Kirsanova
    Abstract: This paper studies discretionary non-cooperative monetary and …fiscal policy stabilization in a New Keynesian model, where the …fiscal policymaker uses a distortionary tax as the policy instrument and operates with long periods between optimal time-consistent adjustments of the instrument. We demonstrate that longer …fiscal cycles result in stronger complementarities between the optimal actions of the monetary and …fiscal policymakers. When the …fiscal cycle is not very long, the complementarities lead to expectation traps. However, with a sufficiently long …fiscal cycle –one year in our model –no learnable time-consistent equilibrium exists. Constraining the …fiscal policymaker in its actions may help to avoid these adverse effects.
    Keywords: Monetary and fiscal policy interactions, distortionary taxes, discretionary policy, LQ RE models
    JEL: E31 E52 E58 E61 C61
    Date: 2014
  26. By: Garriga, Carlos (Federal Reserve Bank of St. Louis); Tang, Yang (Nanyang Technological University); Wang, Ping (Washington University)
    Abstract: This paper explores the role played by structural transformation and the resulting relocation of workers from rural to urban areas in the recent housing boom in China. This development process has fostered an ongoing increase in urban housing demand, which, combined with a relatively inelastic supply due to land and entry restrictions, has raised housing and land prices. We examine the issue using a multi-sector dynamic general-equilibrium model with endogenous rural-urban migration and endogenous housing demand and supply. Our quantitative results suggest that the development process accounts for two-thirds of housing and land price movements across all urban areas. This mechanism is amplified in an extension calibrated to the two largest cities indicating that market fundamentals remain a key driver of housing and land prices.
    Keywords: Migration; structural transformation; housing boom
    JEL: D90 E20 O41 R23 R31
    Date: 2014–10–01
  27. By: Andries Brandsma; d'Artis Kancs; Philippe Monfort; Alexandra Rillaers
    Abstract: The paper presents the newly developed dynamic spatial general equilibrium model of European Commission, RHOMOLO. The model incorporates several elements from economic geography in a novel and theoretically consistent way. It describes the location choice of different types of agents and captures the interplay between agglomeration and dispersion forces in determining the spatial equilibrium. The model is also dynamic as it allows for the accumulation of factors of production, human capital and technology. This makes RHOMOLO well suited for simulating policy scenario related to the EU cohesion policy and for the analysis of its impact on the regions and the Member States of the union.
    Date: 2014–10
  28. By: Hugo Benítez-Silva; J. Ignacio García-Pérez; Sergi Jiménez-Martín
    Abstract: The discussion about the need for Social Security reforms has recently resurfaced, and is expected to continue to be part of the political agenda in the near future. Our paper is a step in the direction of providing a framework for policy analysis that accounts for employment uncertainty, something that has been relatively overlooked in terms of its link with retirement decisions. In this context, we explicitly consider the participation decision of older individuals along with their decision to claim Social Security retirement benefits, using a sequential decision structure. We have numerically solved and simulated a benchmark model of the inter-temporal decision problem that individuals face in the United States. Our results show that the model is able to explain with great accuracy the strikingly high proportion of individuals who claim benefits exactly at the Early Retirement Age. The model is also able to replicate the declining labor force participation at older ages. Additionally, we discuss a number of policy experiments that suggest that individuals claiming and labor supply decisions are responsive to measures likely to be on the table for policy makers when considering the reforms of the U.S. Social Security system.
    Date: 2014–10
  29. By: Nicolas Petrovsky-Nadeau (Tepper School of Business); Etienne Wasmer (Département d'économie); Shutian Zeng
    Abstract: The renewal of interest in macroeconomic theories of search frictions in the goods market requires a deeper understanding of the cyclical properties of the intensive margins in this market. We review the theoretical mechanisms that promote either procyclical or countercyclical movements in time spent searching for consumer goods and services, and then use the American Time Use Survey to measure shopping time through the Great Recession. Average time spent searching declined in the aggregate over the period 2008-2010 compared to 2005-2007, and the decline was largest for the unemployed who went from spending more to less time searching for goods than the employed. Cross-state regressions point towards a procyclicality of consumer search in the goods market. At the individual level, time allocated to different shopping activities is increasing in individual and household income. Overall, this body of evidence supports procyclical consumer search effort in the goods market and a conclusion that price comparisons cannot be a driver of business cycles.
    Keywords: Goods market search; time allocation; American Time Use Survey; business cycles
    JEL: D12 E32 J22
    Date: 2014–10

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.