nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒05‒30
29 papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. Financial frictions in a DSGE model for Latvia By Ginters, Buss
  2. A Multi-sector Model of the Australian Economy By Daniel Rees; Penelope Smith; Jamie Hall
  3. Imperfect information about financial frictions and consequences for the business cycle By Hollmayr, Josef; Kühl, Michael
  4. Fundamental shock selection in DSGE models By Filippo Ferroni; Stefano Grassi; Miguel A. Leon-Ledesma
  5. Animal spirits, investment and unemployment: An old Keynesian view of the Great Recession By Guerrazzi, Marco
  6. Optimal taxation and debt with uninsurable risks to human capital accumulation By Piero Gottardi; Atsushi Kajii; Tomoyuki Nakajima
  7. News Shocks and Labor Market Dynamics in Matching Models By Konstantinos Theodoridis; Francesco Zanetti
  8. Semi-Global Solutions to DSGE Models: Perturbation around a Deterministic Path By Ajevskis, Viktors
  9. The Macroeconomic Effects of Fiscal Consolidation in Dynamic General Equilibrium By Schwarzmüller, Tim; Wolters, Maik H.
  10. Large firm dynamics and the business cycle By Vasco Carvalho; Basile Grassi
  11. News shocks and asset prices By Aytek Malkhozov; Andrea Tamoni
  12. Heterogeneity in decentralized asset markets By Hugonnier, Julien; Lester, Benjamin; Weill, Pierre-Olivier
  13. Foreign Capital Flows, Credit Growth and Macroprudential Policy in a DSGE Model with Traditional and Matter-of-Fact Financial Frictions By Fabia A. de Carvalho; Marcos R. Castro
  14. The Cost of Job Loss By Burdett, Ken; Carrillo-Tudela, Carlos; Coles, Melvyn G.
  15. Replica Core Equivalence Theorem: An Extension of the Debreu-Scarf Limit Theorem to Double Infinity Monetary Economies By Ken Urai; Hiromi Murakami
  16. Stochastic Unemployment with Dynamic Monopsony By Melvyn G Coles; Dale T Mortensen
  17. Dynamic equilibrium with rare events and heterogeneous epstein-zin investors By Georgy Chabakauri
  18. Optimal Taxation and Human Capital Policies over the Life Cycle By Stefanie Stantcheva
  19. Fiscal austerity, unemployment and family firms By Munkacsi, Zsuzsa
  20. Mismatch Shocks and Unemployment During the Great Recession By Nicolas Groshenny; Francesco Furlanetto
  21. Labor Market Policies and the "Missing Deflation" Puzzle: Lessons from Hoover Policies during the U.S Great Depression By Jordan Roulleau-Pasdeloup; Anastasia Zhutova
  22. German and the rest of euro area fiscal policy during the crisis By Gadatsch, Niklas; Hauzenberger, Klemens; Stähler, Nikolai
  23. Risk, Financial Development and Firm Dynamics By Morais, Bernardo
  24. Sovereign Default: The Role of Expectations By Nicolini, Juan Pablo; Teles, Pedro; Ayres, Joao Luiz; Navarro, Gaston
  25. Inequalities in an OLG economy with heterogeneity within cohorts and an obligatory pension systems By Marcin Bielecki; Joanna Tyrowicz; Krzysztof Makarski; Marcin Waniek
  26. Long Run Expectations, Learning and the U.S. Housing Market By Daniel Tortorice
  27. Life-Cycle Consumption and Children: Evidence from a Structural Estimation By Thomas H. Jørgensen
  28. Do Job Destruction Shocks Matter in the Theory of Unemployment? By Melvyn G Coles; Ali Moghaddasi Kelishomi
  29. A Rational Economic Model of Paygo Tax Rates By Shehsinski, Eytan; de Menil, Georges; Murtin, Fabrice

  1. By: Ginters, Buss
    Abstract: This paper builds a dynamic stochastic general equilibrium (DSGE) model for Latvia that would be suitable for policy analysis and forecasting purposes at Bank of Latvia. For that purpose, I adapt the DSGE model with financial frictions of Christiano, Trabandt and Walentin (2011) to Latvia’s data, estimate it, and study whether adding the financial frictions block to an otherwise identical (‘baseline’) model is an improvement with respect to several dimensions. The main findings are: i) the addition of financial frictions block provides more appealing interpretation for the drivers of economic activity, and allows to reinterpret their role; ii) financial frictions played an important part in Latvia’s 2008-recession; iii) the financial frictions model beats both the baseline model and the random walk model in forecasting both CPI inflation and GDP, and performs roughly the same as a Bayesian structural vector autoregression.
    Keywords: DSGE model, financial frictions, small open economy, Bayesian estimation, Currency union
    JEL: E0 E3 F0 F4 G0 G1
    Date: 2015–05
  2. By: Daniel Rees (Reserve Bank of Australia); Penelope Smith (Reserve Bank of Australia); Jamie Hall (Reserve Bank of Australia)
    Abstract: This paper describes the dynamic stochastic general equilibrium (DSGE) model currently in use at the Reserve Bank of Australia. The model extends previous DSGE models of the Australian economy by incorporating multiple production sectors, including a resource sector. We estimate the model, describe its dynamic properties, illustrate its use in scenario analysis and use the model to identify the sources of Australian business cycle fluctuations.
    Keywords: monetary policy; small open economy; Bayesian estimation
    JEL: C11 E47 E52
    Date: 2015–05
  3. By: Hollmayr, Josef; Kühl, Michael
    Abstract: In this paper, we discuss the consequences of imperfect information about financial frictions on the macroeconomy. We rely on a New Keynesian DSGE model with a banking sector in which we introduce imperfect information about a limited enforcement problem. Bank managers divert resources and can increase the share of diversion. This can only be observed imperfectly by depositors. The ensuing imperfect information generates a higher volatility of the business cycle. Spillovers from the financial sector to the real economy are higher and shocks in general are considerably amplified in the transition period until agents' learning is complete. Volatility and second-order moments also display an amplification under the learning setup compared with the rational expectations framework.
    Keywords: DSGE Model,Financial Frictions,Learning
    JEL: E3 E44 G3
    Date: 2015
  4. By: Filippo Ferroni; Stefano Grassi; Miguel A. Leon-Ledesma
    Abstract: DSGE models are typically estimated assuming the existence of certain structural shocks that drive macroeconomic fluctuations. We analyze the consequences of introducing nonfundamental shocks for the estimation of DSGE model parameters and propose a method to select the structural shocks driving uncertainty. We show that forcing the existence of non-fundamental structural shocks produces a downward bias in the estimated internal persistence of the model. We then show how these distortions can be reduced by allowing the covariance matrix of the structural shocks to be rank deficient using priors for standard deviations whose support includes zero. The method allows us to accurately select fundamental shocks and estimate model parameters with precision. Finally, we revisit the empirical evidence on an industry standard medium-scale DSGE model and find that government, price, and wage markup shocks are non-fundamental.
    Keywords: Reduced rank covariance matrix; DSGE models; stochastic dimension search
    JEL: C10 E27 E32
    Date: 2015–05
  5. By: Guerrazzi, Marco
    Abstract: This paper develops a DSGE model with investment and capital accumulation build along demand-driven explanations of the Great Recession. Specifically, following Farmer (2013), I set forth a search framework in which households decide about consumption while firms decide about recruiting effort as well as investment. This setting closed with market clearing in good and asset markets has one less equation than unknowns. Therefore, in order to solve such an indeterminacy, I assume that investment is driven by self-fulfilling expectations about the adjustment cost of capital. Consistently with the view of business cycles pushed by stock price fluctuations, this model has the potential to provide a more comprehensive rationale of the consumption-investment patterns observed during the years of the crisis.
    Keywords: Investment; Capital accumulation; Finance-induced recession; Search, DSGE Models
    JEL: E24 E32 E58
    Date: 2015–05–23
  6. By: Piero Gottardi (European University Institute); Atsushi Kajii (Kyoto University and Singapore Management University); Tomoyuki Nakajima (Kyoto University and CIGS)
    Abstract: We consider an economy where individuals face uninsurable risks to their human capital accumulation, and analyze the optimal level of linear taxes on capital and labor income together with the optimal path of government debt. We show that in the presence of such risks it is beneficial to tax both labor and capital and to issue public debt. We also assess the quantitative importance of these findings, and show that the benefits of government debt and capital taxes both increase with the magnitude of idiosyncratic risks and the degree of relative risk aversion.
    Keywords: incomplete markets; Ramsey equilibrium; optimal taxation; optimal public debt.
    JEL: D52 D60 D90 E20 E62 H21 O40
    Date: 2015–03
  7. By: Konstantinos Theodoridis (Bank of England); Francesco Zanetti (University of Oxford)
    Abstract: We enrich a baseline RBC model with search and matching frictions on the labor market and real frictions that are helpful in accounting for the response of macroeconomic aggregates to shocks. The analysis allows shocks to have an unanticipated and a news (i.e. anticipated) component. The Bayesian estimation of the model reveals that the model which includes news shocks on macroeconomic aggregates produces a remarkable fit of the data. News shocks in stationary and non-stationary TFP, investment-specific productivity and preference shocks significantly affect labor market variables and explain a sizeable fraction of macroeconomic fluctuations at medium- and long-run horizons. Historically, news shocks have played a relevant role for output, but they have had a limited influence on unemployment.
    Keywords: Anticipated productivity shocks, Bayesian SVAR methods, labor market search frictions.
    JEL: E32 C32 C52
    Date: 2015–04
  8. By: Ajevskis, Viktors
    Abstract: This study presents an approach based on a perturbation technique to construct global solutions to dynamic stochastic general equilibrium models (DSGE). The main idea is to expand a solution in a series of powers of a small parameter scaling the uncertainty in the economy around a global solution to the deterministic model, i.e. the model where the volatility of the shocks vanishes. Under the assumption that a deterministic path is already known the higher order terms in the expansion are obtained recursively by solving linear rational expectations models with time-varying parameters. The present work proposes a method based on backward recursion for solving this type of models. The conditions under which the solutions exist are found.
    Keywords: DSGE, perturbation, rational expectations, time-varying parameters, backward induction
    JEL: C62 D58 D84
    Date: 2015–05
  9. By: Schwarzmüller, Tim; Wolters, Maik H.
    Abstract: We provide a systematic analysis of the transmission mechanisms of fiscal consolidation via various fiscal instruments in a medium-scale dynamic general equilibrium model. Our analysis shows that the following three aspects have a large impact on the quantitative macroeconomic effects of fiscal consolidation. First, the effects on output depend crucially on the interaction of the specific fiscal consolidation instrument with the production factors labor, private and public capital. Increases in the labor and capital tax rates and cuts in government investment lead to large declines in one of these production factors, respectively. This is followed by a decrease in the private or public capital stock which in turn yields a persistent output contraction. By contrast, for consolidations via government consumption, transfers or the consumption tax rate the capital stock does not shrink and output recovers much faster. Second, the presence of credit-constrained households amplifies the consumption and output dynamics caused by fiscal consolidation. This has large distributional consequences and opposing welfare implications for credit-constrained and fully optimizing households. Finally, when the zero lower bound on the nominal interest rate binds the short-run output costs of fiscal consolidation increase substantially in particular for expenditure based consolidations.
    Keywords: fiscal consolidation, policy transmission, government debt, distortionary taxes, zero lower bound, welfare, monetary-fiscal policy interaction
    JEL: E32 E62 E63 H61 H62 H63
    Date: 2015–05
  10. By: Vasco Carvalho; Basile Grassi
    Abstract: Do large firm dynamics drive the business cycle? We answer this question by developing a quantitative theory of aggregate fluctuations caused by firm-level disturbances alone. We show that a standard heterogeneous firm dynamics setup already contains in it a theory of the business cycle, without appealing to aggregate shocks. We offer a complete analytical characterization of the law of motion of the aggregate state in this class of models – the firm size distribution – and show that the resulting closed form solutions for aggregate output and productivity dynamics display: (i) persistence, (ii) volatility and (iii) time-varying second moments. We explore the key role of moments of the firm size distribution – and, in particular, the role of large firm dynamics – in shaping aggregate fluctuations, theoretically, quantitatively and in the data.
    Keywords: Large Firm Dynamics; Firm Size Distribution; Random Growth; Aggregate Fluctuations.
    Date: 2015–04
  11. By: Aytek Malkhozov; Andrea Tamoni
    Abstract: We study the importance of anticipated shocks (news) for understanding the comovement between macroeconomic quantities and asset prices. We find that four-quarter anticipated investment shocks are an important source of fluctuations for macroeconomic variables: they account for about half of the variance in hours and investment. However, it is the four-quarter anticipated productivity shock that is driving a large fraction of consumption and most of the price-dividend ratio fluctuations. These productivity news are key for the model to reproduce the empirical tendency for stock-market valuations and excess returns to lead the business cycle. Importantly, a model that does not use asset price information in the estimation would downplay the role of productivity news; in this case, the model implies that return moves (almost) completely contemporaneously with the economic activity, counterfactually with the data.
    Keywords: anticipated shocks; sources of aggregate fluctuations; Bayesian estimation; DSGE model
    JEL: C22 E32 E44 G12
    Date: 2015–03–20
  12. By: Hugonnier, Julien (Swiss Finance Institute); Lester, Benjamin (Federal Reserve Bank of Philadelphia); Weill, Pierre-Olivier (University of California, Los Angeles)
    Abstract: We study a search and bargaining model of an asset market, where investors’ heterogeneous valuations for the asset are drawn from an arbitrary distribution. Our solution technique renders the analysis fully tractable and allows us to provide a full characterization of the equilibrium, in closed-form, both in and out of steady-state. We use this characterization for two purposes. First, we establish that the model can naturally account for a number of stylized facts that have been documented in empirical studies of over-the-counter asset markets. In particular, we show that heterogeneity among market participants implies that assets are reallocated through “intermediation chains,” ultimately producing a core-periphery trading network and non-trivial distributions of prices and trading times. Second, we show that the model generates a number of novel results that underscore the importance of heterogeneity in decentralized markets. We highlight two: First, heterogeneity magnifies the price impact of search frictions; and second, search frictions have larger effects on price levels than on price dispersion. Hence, quantifying the price discount or premium created by search frictions based on observed price dispersion can be misleading.
    Keywords: Search frictions; Bargaining; Continuum of types; Price dispersion
    JEL: G11 G12 G21
    Date: 2015–05–01
  13. By: Fabia A. de Carvalho; Marcos R. Castro
    Abstract: We investigate the transmission channel of reserve requirements, capital requirements, and risk weights of different types of credit in the computation of capital adequacy ratios and compare the power of each macroprudential instrument to counteract the impact of domestic and international shocks that potentially challenge financial stability. To this end, we model a small open economy that receives inflows of foreign direct investment, foreign portfolio investment, and issues foreign debt. The central bank manages international reserves, with an impact on the foreign exchange market and on the country risk premium. Shocks in international markets affect domestic credit even though foreign capital flows are directly destined to non-financial institutions. Banks operate in four distinct credit markets: consumer, housing and commercial– each of them facing default risk and having specific borrowing constraints– and safe export-related credit lines in the form of working capital loans to exporters. Consumer loans are granted based on banks’ expectations with respect to borrowers’ future labor income net of senior debt services. Banks optimize their balance sheet allocation facing frictions intended to reproduce banks’ incentives given regulatory constraints. The model is estimated with Bayesian techniques using data from Brazil
    Date: 2015–05
  14. By: Burdett, Ken; Carrillo-Tudela, Carlos; Coles, Melvyn G.
    Abstract: In this paper we develop and quantitatively assess a tractable equilibrium search model of the labour market to analyse the long-term wage costs of a job loss. In our framework, these costs occur due to losses in workers' human capital and firm specific compensation, interruptions to workers' on-the-job search and due to turnover heterogeneity. A key feature is that firms post wage-tenure contracts as an optimal response to their employees' search behaviour and human capital accumulation. We estimate the wage losses due to job separation for young workers in the UK and show that our calibrated model fits the observed patterns very well. We use the model to evaluate the importance of each of the components that affect the cost of job loss. Human capital losses exert a strong negative and permanent effect on future wages. The effects of workers' on-the-job search and firms' tenure contracts, although temporary and smaller in size, are long-lasting. It takes workers around 10 years to recover wages through these channels. Human capital losses play a more important role in explaining the extent and persistence of wage losses among low skilled workers. Among high skilled workers, on-the-job search implies re-employment wages start recovering sooner.
    Date: 2015–05–26
  15. By: Ken Urai (Graduate School of Economics, Osaka University); Hiromi Murakami (Graduate School of Economics, Osaka University)
    Abstract: An overlapping generations model with the double infinity of commodities and agents is the most fundamental framework to introduce outside money into a static economic model. In this model, competitive equilibria may not necessarily be Pareto-optimal. Although Samuelson (1958) emphasized the role of fiat money as a certain kind of social contract, we cannot characterize it as a cooperative game-theoretic solution like a core. In this paper, we obtained a finite replica core characterization of Walrasian equilibrium allocations under non-negative wealth transfer and a core-limit characterization of Samuelsonfs social contrivance of money. Preferences are not necessarily assumed to be ordered.
    Keywords: Monetary Equilibrium, Overlapping Generations Model, Core Equivalence, Replica Econ- omy, Non-Ordered Preference
    JEL: C62 C71 D51 E00
    Date: 2014–11
  16. By: Melvyn G Coles; Dale T Mortensen
    Abstract: This paper considers an equilibrium labour market with on-the-job search where heterogeneous ?rms, both by productivity and size, post wages and choose optimal hiring strategies. There are aggregate and ?rm speci?c pro- ductivity shocks. Industry dynamics are rich. By comparing the market out- come to the competitive allocation, simple numerical examples establishes how dynamic monopsony generates excessive job-to-job turnover, excessive job destruction rates at low productivity ?rms and so generates "too high" unemployment. It explains why gross hire ?ows and gross separation ?ows may be large and volatile, yet yield an unemployment process which is highly persistent.
    Date: 2015–05–06
  17. By: Georgy Chabakauri
    Abstract: We consider a general equilibrium Lucas (1978) economy with one consumption good and two heterogeneous Epstein-Zin investors. The output is subject to rare large drops or, more generally, can have non-lognormal distribution with higher cumulants. The heterogeneity in preferences generates excess stock return volatilities, procyclical price-dividend ratios and interest rates, and countercyclical market prices of risk when the elasticity of intertemporal substitution (EIS) is greater than one. Moreover, the latter results cannot be jointly replicated in a model where investors have EIS ≤ 1 or CRRA preferences. We propose new approach for deriving equilibrium, and extend the analysis to the case of heterogeneous beliefs about probabilities of rare events.
    Keywords: heterogeneous investors; Epstein-Zin preferences; rare events; equilibrium; portfolio choice
    JEL: D53 G11 G12
    Date: 2015–03–20
  18. By: Stefanie Stantcheva
    Abstract: This paper derives optimal income tax and human capital policies in a dynamic life cycle model of labor supply and risky human capital formation. The wage is a function of both stochastic, persistent, and exogenous "ability'' and endogenous human capital. Human capital is acquired throughout life through monetary expenses. The government faces asymmetric information regarding the initial ability of agents and the lifetime evolution of ability, as well as the labor supply. The optimal subsidy on human capital expenses is determined by three considerations: counterbalancing distortions to human capital investment from the taxation of wage and capital income, encouraging labor supply, and providing insurance against adverse draws from the productivity distribution. When the wage elasticity with respect to ability is increasing in human capital, the optimal subsidy involves less than full deductibility of human capital expenses on the tax base, and falls with age. I consider two ways to implement the optimum: income contingent loans, and a tax scheme that allows for a deferred deductibility of human capital expenses. Numerical results are presented that suggest that full dynamic risk-adjusted deductibility of expenses might be close to optimal, and that simple linear age-dependent policies can achieve most of the welfare gain from the second best.
    JEL: H21 H23 I21 I22 I24
    Date: 2015–05
  19. By: Munkacsi, Zsuzsa
    Abstract: I calculate unemployment multipliers of fiscal consolidation policies in a standard, closed-economy New Keynesian framework with search and matching frictions, and, as an innovation, in the presence of sectoral heterogeneity. Family and non-family firms behave differently in the labor market and are differently managed. This latter assumption is modeled by the inclusion of intangible capital in the family sector. The model is calibrated to match European data on countries with a large percentage of family firms in the labor force. I find that fiscal austerity raises unemployment. Both at peak and cumulatively, unemployment reacts least when the budget is consolidated by increasing the rate of value-added tax. At peak, the highest increase in unemployment is induced by a cut in government consumption, but, cumulatively, a hike in employees' labor income tax is just as costly in terms of employment. There are trade-offs, however, which a policymaker must face, as the value-added tax increase results in the steepest decline in consumption. Sectoral heterogeneity is crucial; multipliers of labor income tax policies and government consumption multipliers are usually biased downwards, while the consumption-tax multipliers are often biased upwards. Thus, ignoring sectoral heterogeneity might lead to incorrect policy conclusions.
    Keywords: fiscal austerity,government consumption,labor income tax,consumption tax,social security contribution,unemployment multiplier,sectoral heterogeneity,family firms,intangible capital
    JEL: E22 E24 E62 J64
    Date: 2015
  20. By: Nicolas Groshenny (School of Economics, University of Adelaide); Francesco Furlanetto (Norges Bank (Central Bank of Norway))
    Keywords: Search and matching frictions; Unemployment; Natural rates.
    JEL: E32 C51 C52
  21. By: Jordan Roulleau-Pasdeloup; Anastasia Zhutova
    Abstract: We document the existence of a "missing deflation" puzzle during the U.S. Great Depression (1929-1941) and show that the solution of this puzzle lies in Hoover policies. Herbert Hoover made multiple public announcements asking firms not to cut wages, most of which complied. The consequences of such a policy are ambiguous since it affects aggregate fluctuations via two channels: as a negative aggregate supply shock this policy decreases output while increasing inflation, but more inflation can postpone the occurrence of a liquidity trap when the economy is hit by a large negative aggregate demand shock. We develop and estimate a medium scale New Keynesian model to measure the effect of Hoover policies during the Great Depression and we find evidence that without such polices the U.S. economy would have ended up in a liquidity trap two years before it actually did, suffering an even deeper recession with a larger deflation. In addition, the welfare effects of Hoover policy are found to be clearly positive.
    Keywords: Zero lower bound; Deflation; Great Depression
    JEL: C11 E24 E31 E32 E44 E52 N12
    Date: 2015–05
  22. By: Gadatsch, Niklas; Hauzenberger, Klemens; Stähler, Nikolai
    Abstract: We present the estimated large-scale three-region DSGE model GEAR picturing Germany, the Euro Area and the Rest of the world. Compared to existing models of this type, GEAR incorporates a comprehensive fiscal block, involuntary unemployment and a complex international structure. We use the model to evaluate spillovers of fiscal policy, to calculate various present-value multipliers for distinct fiscal instruments, and to assess how discretionary fiscal policy in Germany and the Euro Area affected GDP growth during the global financial crisis. Our analysis suggests that spillovers of fiscal policy shocks in the Euro Area are small. Overall, spending multipliers are higher than revenue-based multipliers and are in line with those found in the literature. We find that, during the crisis, fiscal stimulus packages increased annualized quarter-on-quarter GDP growth substantially, both in Germany and in the rest of the Euro Area. The main drivers of GDP growth in Europe, however, were rest of the world and uncovered interest rate parity shocks, followed by domestic non-fiscal shocks.
    Keywords: Fiscal Policy,Unemployment,DSGE modeling,Bayesian estimation
    JEL: H2 J6 E32 E62
    Date: 2015
  23. By: Morais, Bernardo (Board of Governors of the Federal Reserve System (U.S.))
    Abstract: I document that the average productivity of firms tends to increase, and its variance to decrease, as they age. These two facts combined suggest that managers learn to reduce their mistakes as they operate. I develop a quantitative framework mimicking these dynamics and find that young firms have substantially higher financing costs due to lower and riskier returns. In this scenario, a reduction in the financial development of an economy raises disproportionately the cost of credit of young-productive firms increasing the input misallocation within this subgroup. To test the validity of the theory, I find that the data confirms some novel predictions on a series of firm-level moments. Finally, I show that introducing these two facts allows the model to better explain the relation between financial and economic development.
    Keywords: productivity; misallocation; financial frictions; learning
    JEL: O11 O40
    Date: 2015–05–06
  24. By: Nicolini, Juan Pablo (Federal Reserve Bank of Minneapolis); Teles, Pedro (Universidade Catolica Portuguesa); Ayres, Joao Luiz (Federal Reserve Bank of Minneapolis); Navarro, Gaston (New York University)
    Abstract: We study a variation of the standard model of sovereign default, as in Aguiar and Gopinath (2006) or Arellano (2008), and show that this variation is consistent with multiple interest rate equilibria. Some of those equilibria correspond to the ones identified by Calvo (1988), where default is likely because rates are high, and rates are high because default is likely. The model is used to simulate equilibrium movements in sovereign bond spreads that resemble sovereign debt crises. It is also used to discuss lending policies similar to the ones announced by the European Central Bank in 2012.
    Keywords: Sovereign default; Interest rate spreads; Multiple equilibria
    JEL: E44 F34
    Date: 2015–05–14
  25. By: Marcin Bielecki (Faculty of Economic Sciences, University of Warsaw); Joanna Tyrowicz (Faculty of Economic Sciences, University of Warsaw; National Bank of Poland); Krzysztof Makarski (National Bank of Poland; Warsaw School of Economics); Marcin Waniek (University of Warsaw)
    Abstract: While the inequalities of endowments are widely recognized as areas of policy intervention, the dispersion in preferences may also imply inequalities of outcomes. In this paper, we analyze the inequalities in an OLG model with obligatory pension systems. We model both policy relevant pension systems (a defined benefit system -- DB -- and a transition from a DB to a defined contribution system, DC). We introduce within cohort heterogeneity of endowments (individual productivities) and heterogeneity of preferences (preference for leisure and time preference). We introduce two policy instruments, which are widely used: a contribution cap and a minimum pension. In theory these instruments affect both the incentives to work and the incentives to save for the retirement with different strength and via different channels, but the actual effect attributable to these policy instruments cannot be judged in an environment with a single representative agent. We show four main results. First, longevity increases aggregate consumption inequalities substantially in both pension systems, whereas the effect of a pension system reform works to reinforce the consumption inequalities and reduce the wealth inequalities. Second, the contribution cap has negligible effect on inequalities, but the role for minimum pension benefit guarantee is more pronounced. Third, the reduction in inequalities due to minimum pension benefit guarantee is achieved with virtually no effect on capital accumulation. Finally, the minimum pension benefit guarantee addresses mostly the inequalities which stem from differentiated endowments and not those that stem from differentiated preferences.
    Keywords: inequality, longevity, defined contribution, defined benefit, Gini
    JEL: C68 E17 E21 J11 J26 H55 D63
    Date: 2015
  26. By: Daniel Tortorice (Brandeis University)
    Abstract: This paper examines key facts about the U.S. housing market. The price to rent ratio is highly volatile and significantly autocorrelated. Returns on housing are positively autocorrelated. The price to rent ratio is negatively correlated with future returns on housing and future rent growth. Finally, housing returns exhibit significant time varying volatility. I show that a benchmark rational expectations general equilibrium asset pricing model is inconsistent with these facts. I modify the model in two ways to improve its fit with the data. First, I allow for pricing frictions so prices adjust slowly to their fundamental value. Second, I assume the agent does not know if housing fundamentals, captured by rental flows, are stationary or non-stationary and has changing beliefs depending on how well each model fits the current data. I find that these modifications allow the model to increase the volatility of the price to rent ratio and to match the autocorrelation of housing returns. The price to rent ratio then negatively forecasts returns and rent growth. Finally the model generates time varying volatility consistent with the data.
    Keywords: Learning, Expectations, Housing Demand, Asset Pricing
    JEL: D83 D84 G12 R21
    Date: 2015–05
  27. By: Thomas H. Jørgensen (Department of Economics, University of Copenhagen)
    Abstract: I study how children affect the marginal utility of non-durable consumption.I estimate by Maximum Likelihood a structural economic model of optimal intertemporal allocation of consumption in the presence of children using high quality Danish administrative longitudinal data. Contrary to existing studies, I allow income uncertainty, credit constraints, and post-retirement motives to affect household behavior while the number and age of all children can affect the marginal utility of consumption. I estimate that children have a negligible effect on the marginal utility of non-durable consumption. To reconcile these results with existing studies, typically estimating an important role for children while ignoring precautionary motives, I illustrate how ignoring precautionary motives increases the estimated importance of children. I interpret the results as indicating that precautionary motives might play a larger role than children in explaining the observed consumption age profile.
    Keywords: Consumption, Children, Precautionary saving, Life cycle, Structural Estimation
    JEL: D12 D14 D91
    Date: 2015–05–26
  28. By: Melvyn G Coles; Ali Moghaddasi Kelishomi
    Abstract: The current DMP approach to labor markets presumes job destruction shocks are small. We relax that assumption and also allow unlled jobs, like unemployment, to evolve as a state variable. Calibrating an otherwise standard DMP framework, we identify a remarkable, (almost) perfect, fit of the empirical facts as reported in Shimer (2005, 2012). The results, how- ever, are also consistent with the insights of Davis and Haltiwanger (1992): that unemployment volatility is driven by large but infrequent job separation shocks. The approach not only provides an important synthesis of two litera- tures which, in other contexts, have appeared contradictory, it also identfies a more traditional view of the timing and progression of recessions.
    Date: 2014–02–01
  29. By: Shehsinski, Eytan; de Menil, Georges; Murtin, Fabrice
    Abstract: We argue that a rational-economic model of how societies choose their paygo tax rate can explain the cross section variance of these rates in large, developed OECD economies. Using a two-period OLG framework, we suggest that paygo tax rates are determined by a representative agent and a benevolent government jointly maximizing the expected life-time utility of the representative agent. In order to calculate these expected utilities, we construct probability distributions of life-time labor and capital income by simulating annual models of real wages and the return to capital estimated from data on real GDP and the real return to capital from the end of World War II to 2002. The joint distribution of the error terms is bootstrapped from the estmated errors of the annual equations. Expectations are taken over these distributions. The model predicts that each country chooses the paygo tax rate which maximizes the expected life-time utility of its representative agent. Risk aversion, described by a CRRA utility function, is assumed uniform across countries, such that the variance of the predicted rates is due exclusively to cross-country differences in the objective characteristics of the dynamics of wages and the return to capital in each country. These predicted rates are shown to explain 85% of the variance of observed effective-paygo rates. The calculations show that it is cross-country differences in the level and variability of the return to capital which are the most important source of this variance. We use the model to simulate a hypothetical world in which all countries share a unique, global capital market, and show that this scenario leads to a radical convergence of paygo rates. In a further exercise, we add an estimate of the probability of global crises like that of 2008 to the national distributions computed from post-War data, and examine the potential effect on paygo rates of these previously neglected, low probability events.
    Keywords: Pay-as-you-go, Savings, Risk Aversion, OLG, National Capital Markets
    JEL: H0
    Date: 2014

This nep-dge issue is ©2015 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.