nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2015‒08‒01
eleven papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The Dynamics of Development: Entrepreneurship, Innovation, and Reallocation By Roberto Fattal Jaef; Francisco Buera
  2. The Impact of Firing Restrictions on Labor Market Equilibrium in the Presence of On-the-job Search By Fabien Postel-Vinay; Hélène Turon
  3. Trading Fees and Slow-Moving Capital By Buss, Adrian; Dumas, Bernard J
  4. Intermediary Balance Sheets By Nina Boyarchenko; Tobias Adrian
  5. Due Diligence: Job Search with Rationally Inattentive Workers By Daniel Martin; Chris Tonetti; Andrew Caplin; Joseph Briggs
  6. Public Sector Wage Policy and Labor Market Equilibrium: A Structural Model By Jake Bradley; Fabien Postel-Vinay; Hélène Turon
  7. The Carry Trade and UIP when Markets are Incomplete By Lorenzo Garlappi; Jack Favilukis
  8. The Ins and Outs of Selling Houses By Kevin Sheedy; Rachel Ngai
  9. Hyperbolic Discounting and Life-Cycle Portfolio Choice By David Love; Gregory Phelan
  10. An Assignment Model of Knowledge Diffusion and Income Inequality By Erzo Luttmer
  11. Bank Liabilities Channel By Vincenzo Quadrini

  1. By: Roberto Fattal Jaef (The World Bank); Francisco Buera (Federal Reserve Bank of Chicago)
    Abstract: Development dynamics are characterized by sustained improvements in TFP, protracted increases in investment rates, and a broad transformation in the struc- ture of production. Low income countries are characterized by small average firm size, slow firm growth over the life-cycle, and significant dispersion of marginal products. In this paper we present a quantitative theory that jointly matches the behavior of firms in under-developed economies and key properties of develop- ment paths. We work with a model that features endogenous innovation decisions by entrepreneurs, reallocation of factors due to idiosyncratic productivity shocks, and selection in and out of entrepreneurship. We construct a low-TFP stationary equilibrium with dispersion in marginal products that is driven by idiosyncratic distortions. We then trigger development through a reform that liberalizes the economy from all frictions. Our quantitative theory can account well for cross- sectional and life-cycle patterns in distorted economies, and can generate develop- ment paths with rising TFP and investment dynamics, consistent with the data. Ignoring either endogenous innovation or selection in and out of entrepreneurship would lead to counter-factual transition paths, similar to those of the standard neoclassical growth model.
    Date: 2015
  2. By: Fabien Postel-Vinay (Departement d'Economie de Sciences Po); Hélène Turon (Department of Economics (University of Bristol))
    Abstract: Job-to-job turnover provides a way for employers to escape statutory firing costs, as unprofitable workers may willfully quit their job on receiving an outside offer, or may be induced to accept one that they would otherwise reject with a negotiated severance package. We formalise those mechanisms within an extension of the Diamond–Mortensen–Pissarides model that allows for employed job search. We find that our model explains why higher firing costs intensify job-to-job turnover at the expense of transitions out of unemployment and that ignoring on-the-job Search leads one to overstate the adverse impact of firing costs on employment.
    Keywords: Firing restrictions; Labour market equilibrium; Productivity shocks; Wage cuts
    Date: 2014–03
  3. By: Buss, Adrian; Dumas, Bernard J
    Abstract: In some situations, investment capital seems to move slowly towards profitable trades. We develop a model of a financial market in which capital moves slowly simply because there is a proportional cost to moving capital. We incorporate trading fees in an infinite-horizon dynamic general-equilibrium model in which investors optimally and endogenously decide when and how much to trade. We determine the steady-state equilibrium no-trade zone, study the dynamics of equilibrium trades and prices and compare, for the same shocks, the impulse responses of this model to those of a model in which trading is infrequent because of investor inattention.
    Keywords: frictions; general equilibrium; slow-moving capital; Trading fees
    JEL: G11 G12
    Date: 2015–07
  4. By: Nina Boyarchenko (Federal Reserve Bank of New York); Tobias Adrian (Federal Reserve Bank of New York)
    Abstract: We document cyclical properties of balance sheets of different types of intermediaries. While the leverage of the bank sector is highly procyclical, the leverage of the nonbank financial sector is acyclical. We propose a theory of a two-agent financial intermediary sector within a dynamic model of the macroeconomy. Banks are financed by issuing risky debt to households and face risk-based capital constraints, which leads to procyclical leverage. Households can also participate in financial markets by investing in a nonbank ``fund'' sector where fund managers face skin-in-the-game constraints, leading to acyclical leverage in equilibrium. The model also reproduces the empirical feature that banking sector leverage growth leads financial sector asset growth, while the fund sector does not. The procyclicality of the banking sector arises due to its risk based funding constraints, which give a central role to the time variation of endogenous uncertainty.
    Date: 2015
  5. By: Daniel Martin (Paris School of Economics); Chris Tonetti (Stanford GSB); Andrew Caplin (New York University); Joseph Briggs (New York University)
    Abstract: We develop a model of late in life job search that accounts for end of life labor force exit and re-entry. Our key assumptions are that job offers consist of both wage and complex non-wage characteristics and that older workers care more about the non-wage characteristics of a job. In equilibrium, young workers choose jobs with high wages, but poor non-wage characteristics, while older workers are willing to trade off lower wages for better non-wage characteristics. However, due to rational inattention, older workers may ex-post regrettably accept low wage jobs with poor non-wage characteristics. Such mistakes produce welfare losses and generate employment patterns in the model consistent with the empirical patterns of older US workers.
    Date: 2015
  6. By: Jake Bradley; Fabien Postel-Vinay (Departement d'Economie de Sciences Po); Hélène Turon (Department of Economics (University of Bristol))
    Abstract: We develop and estimate a structural model that incorporates a sizable public sector in a labor market with search frictions. The wage distribution and the employment rate in the public sector are taken as exogenous policy parameters. Overall wage distribution and employment rate are determined within the model, taking into account the private sector's endogenous response to public sector employment policies. Job turnover is sector specific and transitions between sectors depend on the worker's decision to accept alternative employment in the same or different sector by comparing the value of employment in the current and prospective jobs. The model is estimated on British data by a method of moments. We use the model to simulate the impact of various counterfactual public sector wage and employment policies.
    Keywords: Labour market; Policy market; Employment rate; Public sector
    Date: 2014–12
  7. By: Lorenzo Garlappi (UBC); Jack Favilukis (University of British Columbia)
    Abstract: We propose a new model to explain the failure of UIP and the profitability of the carry trade and to link these two phenomena to the Balassa-Samuelson effect and the Backus-Smith puzzle. The key features of our model are market incompleteness and partial risk sharing through tradable goods. In the model, carry trade profits are due to two independent channels. First, a purely nominal channel, which works even in complete markets, makes the carry trade risky due to (endogenously) counter-cyclical inflation. Second, a real channel, which, due to imperfect risk sharing, makes the carry trade risky exactly when risk sharing is needed most. The model is consistent with several empirical facts. In particular: (i) real and nominal currency appreciations are positively related to local output growth, (ii) carry trade profits are positively related to output growth and negatively to inflation in the target (high interest rate) country, (iii) ex-ante, target countries are smaller and have higher expected inflation volatility, but there do not appear to be systematic differences between high and low interest rate countries in loadings on world output growth, in expected output growth, or in output volatility. Leading existing models give opposite predictions.
    Date: 2015
  8. By: Kevin Sheedy (London School of Economics); Rachel Ngai (london school of economics)
    Abstract: The number of houses for sale is as volatile as sales volume and much more volatile than house prices, yet it has received relatively little attention. What drives volatility in the number of houses for sale? Is it due to changes in the diculty of selling houses or changes in the incentive to put houses up for sale? This paper presents evidence that both inflows and outflows are important using a variance decomposition. It then uses a search-and-matching model with both the decision of when to agree a sale (outflows) and the decision of when to put a house up for sale (inflows) to understand the behaviour of sales, listings, and prices in the housing market. Quantitatively, the model does a much better job of matching relative volatility and correlations between housing-market variables than those that abstract from the inflow decision.
    Date: 2015
  9. By: David Love (Williams College); Gregory Phelan (Williams College)
    Abstract: This paper studies how hyperbolic discounting affects stock market participation, asset allocation, and saving decisions over the life cycle in an economy with Epstein-Zin preferences. Hyperbolic discounting affects saving and portfolio decisions through at least two channels: (1) it lowers desired saving, which decreases financial wealth relative to future earnings; and (2) it lowers the incentive to pay a fixed cost to enter the stock market. We find that hyperbolic discounters accumulate less wealth relative to their geometric counterparts and that they participate in the stock market at a later age. Because they have lower levels of financial wealth relative to future earnings, hyperbolic discounters who do participate in the stock market tend to hold a higher share of equities, particularly in the retirement years. We find that increasing the elasticity of intertemporal substitution, holding risk aversion constant, greatly magnifies the impact of hyperbolic discounting on all of the model's decision rules and simulated levels of participation, allocation, and wealth. Finally, we introduce endogenous financial knowledge accumulation and find that hyperbolic discounting leads to lower financial literacy and inefficient stock market investment.
    Keywords: Hyperbolic discounting, Epstein-Zin, portfolio choice, financial literacy
    JEL: G11 G22 D91 E21
    Date: 2015–07
  10. By: Erzo Luttmer (University of Minnesota)
    Abstract: Randomness in individual discovery tends to spread out productivities in a population, while learning from others keeps productivities together. In combination, these two mechanisms for knowledge accumulation give rise to long-term growth and persistent income inequality. This paper considers a world in which those with more useful knowledge can teach those with less useful knowledge, with competitive markets assigning students to teachers. In equilibrium, students who are able to learn quickly are assigned to teachers with the most productive knowledge. The long-run growth rate of this economy is governed by the rate at which the fastest learners can learn. The income distribution reflects learning ability and serendipity, both in individual discovery and in the assignment of students to teachers. Because of naturally arising indeterminacies in this assignment, payoff irrelevant characteristics can be predictors of individual income growth. Ability rents can be large when fast learners are scarce, when the process of individual discovery is not too noisy, and when overhead labor costs are low.
    Date: 2015
  11. By: Vincenzo Quadrini (USC)
    Abstract: The financial intermediation sector is important not only for channeling resources from agents in excess of funds to agents in need of funds (lending channel). By issuing liabilities it also creates financial assets held by other sectors of the economy for insurance purpose. When the intermediation sector creates less liabilities or their value falls, agents are less willing to engage in activities that are individually risky but desirable in aggregate (bank liabilities channel). The paper studies how financial crises driven by self-fulfilling expectations are transmitted, through this channel, to the real sector of the economy.
    Date: 2015

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