Endogenous Capital Accumulation Research Articles

Some Unconventional Properties of New Keynesian DSGE Models

We examine the theoretical and numerical properties of a prototypical New Keynesian DSGE model featuring endogenous capital accumulation and labour supply. We find that this completely conventional model yields implausible impact results following unanticipated and temporary shocks when the monetary closure rule is changed from a policy rule setting nominal interest rates (a Taylor Rule) to a fixed money supply rule. We compare and contrast a variety of New Keynesian models, featuring aggregate price stickiness, with their New Classical counterparts featuring perfectly flexible prices. In line with the literature we find that under a Taylor Rule the impulse-response functions following a technology shock are very similar. In contrast, with a fixed money supply the impact effects for the New Keynesian model are implausible. We demonstrate the robustness of this Implausible Result to alternative parameter values and show that it is ultimately caused by the inflexibility of the capital stock relative to that of the real money supply. We suggest several model extensions which will eliminate the Implausible Result from New Keynesian sticky-price models.

Labor Supply Shocks and Capital Accumulation: The Short- and Long-Run Effects of the Refugee Crisis in Europe

European countries experienced a large increase in labor supply due to the influx of Ukrainian refugees after the 2022 Russia invasion of Ukraine. We study its dynamic effects in a spatial model with forward-looking households of different skills, trade, and endogenous capital accumulation. We find that real GDP increases in Europe in the long term, with large distributional effects across countries and skill groups. In the short run, an increase in the supply of labor strains the use of capital structures that takes time to build. Over time, countries that build capital structures increase output, resulting in potential long-run benefits.

Trade Integration, Global Value Chains, and Capital Accumulation

Motivated by increasing trade and fragmentation of production across countries since World War II, we build a dynamic two-country model featuring sequential, multi-stage production and capital accumulation. As trade costs decline over time, global-value-chain (GVC) trade expands across countries, particularly more in the faster growing country, consistent with the empirical pattern. The presence of GVC trade boosts capital accumulation and economic growth and magnifies dynamic gains from trade. At the same time, endogenous capital accumulation shapes comparative advantage across countries, impacting the dynamics of GVC trade: a country becoming more capital abundant concentrates more on the capital-intensive stage of the production. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Discounts, rationing, and unemployment

Abstract How are changes in discount rates transmitted to unemployment, and are they a quantitatively relevant driver of the Great Recession? In this paper I answer these questions using a search and matching model featuring endogenous capital accumulation. Rising discount rates have a direct effect on unemployment, since hiring is an investment activity for firms in the presence of search frictions, and an indirect effect, since a rise in discounts reduces investment in capital, reducing the marginal product of labour and hence incentives to hire. I estimate changes in discount rates during the Great Recession using data on both stock markets and investment. Discounts measured from the stock market increase by more but recover faster, while discounts for capital investment increase by less but more persistently. Combined, the two discount measures can account for 52% of the peak rise in unemployment during the Great Recession. Finally, while capital discounts affect unemployment by changing labour productivity, their importance cannot be inferred from observed movements in labour productivity alone, and capital discounts raised unemployment even while observed labour productivity was rising.

The Minimum Wage Puzzle in Less Developed Countries

We show that a dynamic general equilibrium model with efficiency wages and endogenous capital accumulation in both the formal and (non-agricultural) informal sectors can explain the full range of confounding stylized facts associated with minimum wage laws in less developed countries.

Education, Income, Wealth Inequality and Business Cycles in a General Equilibrium Growth Model

The paper is concerned with the dynamic interactions between physical capital, human capital, income and wealth inequalities between different households with government subsidy to education. It generalizes the endogenous growth model of a small-open economy proposed by Zhang (2016). Zhang’s paper deals with income and wealth inequalities between heterogeneous households with government subsidy to education. The paper makes a contribution to the literature of economic growth with endogenous education by integrating Solow-Uzawa’s neoclassical growth theory, Uzawa-Lucas model, Arrow’s learning by doing, Zhang’s creative leisure, and Walrasian general equilibrium theory. The model treats endogenous capital and human capital accumulation as the main engines of economic growth. This study generalizes Zhang’s model by allowing constant coefficients to be time-dependent. We simulate the generalized model to demonstrate existence of business cycles due to various exogenous periodic shocks.

Endogenous borrowing constraints and stagnation in Latin America

The Latin American debt crisis of the 1980’s had a major and long-lasting effect on per-capita consumption: its level in 2005 was not that different from that in 1980. This paper studies the long stagnation in per-capita consumption that followed the crisis, and its relationship with recessions and sovereign risk, using a small open economy real business cycle model with complete markets, endogenous borrowing limits (limited commitment), endogenous capital accumulation, and domestic productivity and international interest rate shocks. I find that the model does an excellent job at explaining the observed behavior of per-capita consumption and that both the productivity and international interest rate shocks are important. Furthermore, I show that the participation constraint in this kind of representative agent model can bind not only in good times but also in prolonged bad times.

Hitting the Great Wall: Structural change and China's growth slowdown

China is facing slowing growth rates, slowing rates of rural to urban migration and resistance to reforms that would liberalize internal migration restrictions (Hukou). We use a two sector Ramsey growth model and show that, allowing for endogenous capital accumulation, labour reallocation has accounted for approximately one fifth of China's per capita GDP growth over the last 30 years, and that Hukou reform could generate a significant boost to China's per capita GDP growth over the next decade. Our results contrast with conclusions drawn from the traditional growth accounting literature on labour reallocation effects in China because our simulation method allows for endogenous capital accumulation dynamics.

Investment-based optimal capital structure

ABSTRACTThis paper extends the classical capital structure model by introducing the output of firm with ‘AK’ production technology dynamically depends on the endogenous investment decision and capital accumulation. Based on our calibration, it shows that the flexibility of dynamic investment and capital accumulation induces the firm to take the lower leverage at financing time and makes the leverage estimate closer to empirically observed leverage ratios, which provides an effective explanation for the ‘under-leverage puzzle’. In addition, this model predicts that the market leverage behaves in a U-shaped manner with capital liquidity, which provides a novel empirical test.

Sovereign default and capital accumulation

This paper introduces endogenous capital accumulation into an otherwise standard quantitative sovereign default model à la Eaton and Gersovitz (1981). We find that conditional on a level of debt, default incentives are U-shaped in the capital stock: the economy with too small or too large amounts of capital is likely to default. Even without using an ad-hoc output cost of default, the calibrated model generally well matches business cycle facts of emerging economies and generates defaults in “good” and “bad” times, with a frequency of 25.5% and 74.5%, respectively, consistent with Tomz and Wright (2007)’s empirical findings. Simulation results show that the economy defaults in good times when it has “overinvested” in capital during booms before default.

Rethinking Macroeconomic Policy within a Simple Dynamic Model

AbstractWe propose a simple macro‐dynamic model to rethink standard policy prescriptions. Our model includes exogenous growth, endogenous capital accumulation and debt, demand‐driven production with a non‐linear IS curve, a dynamic Phillips curve, and fiscal and monetary policy instruments. It has multiple steady states with different stability properties, and it is analytically tractable to a significant extent. We complete the analytical results with simulations. We find alternative growth patterns, endogenous fluctuations, and demand‐driven level effects even in the long‐run. For certain steady states the model shows saddle‐path type instabilities, which lead us to reflect on fiscal and monetary policy standards.

Capital, institutions and urban growth systems

In recent years, both endogenous capital accumulation and institutional theories of economic growth have emerged as central sources for explaining uneven development across cities and regions. This article seeks to connect both theoretical stances as a means of explaining urban and regional growth differentials. It conceptualises urban and regional economies as growth systems combining the interaction between capital and institutions at the firm, inter-firm and spatial level. In these systems, the capital drivers of growth are not merely the result of preferences and existing capital endowments, but are mediated by a set of institutional factors.

Entrepreneurship versus joblessness: Explaining the rise in self-employment

A large share of the workforce throughout the developing world is self-employed, and this proportion has increased in recent decades. Assessments of this development vary, with pull factors such as high returns to capital contrasted with push factors such as barriers to more desirable salaried jobs. Using a long panel dataset from Ghana, we empirically investigate the changing structure of earnings in self-employment relative to salaried work. Our analysis allows workers to sort into self-employment for different reasons, including expected earnings differentials and endogenous capital accumulation whilst highlighting constraints that workers may face. We estimate a correlated random coefficient model using IV-GMM, taking into account the endogeneity of sector choice and capital accumulation. We find that returns to productive characteristics in self-employment have increased significantly between 2004 and 2011 whilst self-employment has attracted increasingly skilled workers. This points against the negative view of self-employment as an occupation of last resort.

Trade, Capital Accumulation, and the Environment

To highlight endogenous capital accumulation in shaping the interaction between trade and the environment, I develop a two-sector Ramsey model featuring agriculture impaired by pollution from production. Trade raises capital rental and encourages investment. Under laissez faire, this scale effect leads to environmental degradation in the long run, even if the economy specializes in the relatively clean sector. Specialization pattern in the long run depends upon pre-trade comparative advantage. Welfare gains from trade is ambiguous. The social optimum can be achieved through a dynamic version of the Pigouvian tax, with a lump-sum transfer to households. Under optimal policy, trade does not necessarily harm the environment. The long-run specialization pattern may depend upon the initial condition as well.

Capital and Knowledge: Integrating Arrow’s Learning-by-Doing, the Walrasian Equilibrium Theory and Neoclassical Growth Theory

This article proposes a neoclassical growth model with endogenous capital accumulation and knowledge creation. The model integrates Arrow’s learning by doing, Uzawa’s two-sector growth model and Walrasian general equilibrium theory. We use a utility function, which determines leisure time, saving and consumption with utility optimization without leading to a higher dimensional dynamic system like the Ramsey approach. The dynamics of J-household economy is described by a ( J + 1)-dimensional differential equations system. We simulate the motion of the model and demonstrate transitional and long-term effects of changes in the propensity to save, the propensity to use leisure time, the population, the learning-by-doing efficiency and knowledge utilization efficiency. The comparative dynamic analysis provides some insights into issues related to inequality and growth.JEL Classification: D51, D31, O41, E13

When are the Effects of Fiscal Policy Uncertainty Large?

Using a new-Keynesian model with endogenous capital accumulation, I show that uncertainty about fiscal policy can cause large declines in consumption, investment, and output when the zero lower bound (ZLB) binds, but has modest effects when the monetary authority is not constrained by the ZLB. I study uncertainty about the level of government spending and uncertainty about tax rates on consumption, wages, capital income, and investment. In my model, uncertainty about government spending and the wage tax rate has particularly large effects. I show that the effects of fiscal policy uncertainty are largest when the nominal interest rate is on the cusp of the ZLB and also that delaying fiscal policy uncertainty diminishes its effects only if the resolution of uncertainty occurs after ZLB no longer binds.

Robust control, informational frictions, and international consumption correlations

In this paper we examine the effects of model misspecification (robustness or RB) on international consumption correlations in an otherwise standard small open economy model with endogenous capital accumulation. We show that in the presence of capital mobility in financial markets, RB lowers the international consumption correlations by generating heterogeneous responses of consumption to productivity shocks across countries facing different macroeconomic uncertainty. In addition, we show that RB can also improve the model's predictions in three other moments of consumption dynamics: the relative volatility of consumption to income, the persistence of consumption, and the correlation between consumption and output. After calibrating the RB parameter using the detection error probabilities, we show that the model can explain the observed international consumption correlations as well as the other consumption moments quantitatively. Finally, we show that the main conclusions of our benchmark model do not change in an extension in which the agent cannot observe the state perfectly due to finite information-processing capacity.

When are the Effects of Fiscal Policy Uncertainty Large?

Using a new-Keynesian model with endogenous capital accumulation, I show that uncertainty about fiscal policy can cause large declines in consumption, investment, and output when the zero lower bound (ZLB) binds, but has modest effects when the monetary authority is not constrained by the ZLB. I study uncertainty about the level of government spending and uncertainty about tax rates on consumption, wages, capital income, and investment. In my model, uncertainty about government spending and the wage tax rate has particularly large effects. I show that the effects of fiscal policy uncertainty are largest when the nominal interest rate is on the cusp of the ZLB and also that delaying fiscal policy uncertainty diminishes its effects only if the resolution of uncertainty occurs after ZLB no longer binds.

The short and long-run impact of globalization if firms differ in factor input ratios

Empirical evidence has shown that exporters are more capital intensive than non-exporters. Based on this evidence, I construct a two-factor general equilibrium model with firm heterogeneity in factor intensities, monopolistic competition, scale economies and international trade. This setting can explain several empirical regularities on international trade, factor market competition, factor relocations and factor returns: (i) exporters are more capital intensive than non-exporters, regardless of a country's relative factor endowments; (ii) finite supply of capital limits a country's export activities; (iii) trade liberalization increases the relative return to capital; (iv) new profit opportunities in export markets change the distribution of firms towards the more capital intensive ones. Finally, I extend the setting to endogenous capital accumulation and show that trade liberalization induces economic growth and, in the long-run, benefits all factors in real terms.

The Role of Capital on Noise Shocks

An important topic in recent macroeconomic literature is the potential effects of noise, or expectational, shocks on aggregates. Most of the past analysis has used some derivative of a New Keynesian model with labor as the only input, but doing so fails to consider that some input decisions may not have their returns realized today. To capture and explore this possibility under a noise shock framework, I incorporate endogenous capital accumulation in a New Keynesian model and solve for explicit dynamics using the method of undetermined coefficients. Results show that the qualitative predictions hold between my model and that without capital, but inclusion of capital significantly dampens the size of noise shocks: excluding capital raises the initial response of output to a noise shock by more than double. As usable capital on impact is fixed, labor responds less than the no-capital equivalent because it faces diminishing returns to scale. Coupling this effect with quasi-fixed capital accumulation leads to a muted output response in comparison to labor-only models. In addition, noise shocks are transient compared to a permanent shock. This is due to noise shocks being predominantly consumption driven opposed to investment driven. These results suggest that models without capital may overstate the significance of noise shocks.