General Equilibrium Literature Research Articles

The importance of having a more realistic welfare transfer determination rule: A CGE analysis for Ireland

While unemployment benefits constitute a significant share of welfare transfers in developed countries, the computable general equilibrium (CGE) literature ignores the impact of unemployment rate changes on these transfers. This paper investigates the impacts of alternative welfare transfer determination rules by using a dynamic CGE model for Ireland. We find that indexing the nominal welfare transfer budget to the consumer price index (CPI) and the aggregate unemployment rate is superior to the CPI alone. Although both specifications generate similar macroeconomic outcomes, our novel specification improves household welfare as well as income distribution across households. We argue that it is more in line with the behaviour of governments and that the literature ignores the progressivity elements embedded in the welfare system, which will reduce the welfare cost of carbon taxation. The results can be generalised in analysing the impacts of tax reform in countries where unemployment benefits are essential elements of welfare transfers.

A Market-Based Framework for Multi-Resource Allocation in Fog Computing

Fog computing is transforming the network edge into an intelligent platform by bringing storage, computing, control, and networking functions closer to end users, things, and sensors. How to allocate multiple resource types (e.g., CPU, memory, bandwidth) of capacity-limited heterogeneous fog nodes to competing services with diverse requirements and preferences in a fair and efficient manner is a challenging task. To this end, we propose a novel market-based resource allocation framework in which the services act as buyers and fog resources act as divisible goods in the market. The proposed framework aims to compute a market equilibrium (ME) solution at which every service obtains its favorite resource bundle under the budget constraint, while the system achieves high resource utilization. This paper extends the general equilibrium literature by considering a practical case of satiated utility functions. In addition, we introduce the notions of non-wastefulness and frugality for equilibrium selection and rigorously demonstrate that all the non-wasteful and frugal ME are the optimal solutions to a convex program. Furthermore, the proposed equilibrium is shown to possess salient fairness properties, including envy-freeness, sharing-incentive, and proportionality. Another major contribution of this paper is to develop a privacy-preserving distributed algorithm, which is of independent interest, for computing an ME while allowing market participants to obfuscate their private information. Finally, extensive performance evaluation is conducted to verify our theoretical analyses.

General Equilibrium With Uncertainty Loving Preferences

More and more economists are finding both empirical and experimental evidence of economic behavior that is well beyond classical economics. In particular, empirical evidence ( Jullien and Salanie ()) and experimental evidence ( Kahneman and Tversky ()) supported the importance of risk loving, ambiguity loving, and related behavior in economics. However, these types of preferences have not been analyzed in the general equilibrium literature with a finite number of agents because non‐convexity of preferences creates difficulty in proving existence of equilibrium. The main result in this paper provides a set of conditions under which equilibrium exists in such economies. We show that uncertainty of aggregate wealth, as well as some dominance of the endowment of the risk averters in the economy, play a role in the existence of Arrow–Debreu equilibria. This result can be extended to ambiguity in the sense of CEU, Smooth Ambiguity, and Variational Preference.

Dealing with financial instability under a DSGE modeling approach with banking intermediation: A predictability analysis versus TVP-VARs

In the dynamic stochastic general equilibrium (DSGE) literature there has been an increasing awareness on the role that the banking sector can play in macroeconomic activity. We present a DSGE model with financial intermediation as in Gertler and Karadi (2011). The estimation of shocks and of the structural parameters shows that time-variation should be crucial in any attempted empirical analysis. Since DSGE modelling usually fails to take into account inherent nonlinearities of the economy, we propose a novel time-varying parameter (TVP) state-space estimation method for VAR processes both for homoskedastic and heteroskedastic error structures. We conduct an exhaustive empirical exercise to compare the out-of-sample predictive performance of the estimated DSGE model with that of standard ARs, VARs, Bayesian VARs and TVP-VARs. We find that the TVP-VAR provides the best forecasting performance for the series of GDP and net worth of financial intermediaries for all steps-ahead, while the DSGE model outperforms the other specifications in forecasting inflation and the federal funds rate at shorter horizons.

Income Taxation and Risk-Taking

A true income tax is conventionally considered unable to burden the returns to risk-taking. The theory is that investors respond to the tax by increasing the amounts they invest in assets delivering risk-based returns. If the increased investment makes money, the enlarged return covers the associated tax liability; if it loses money, the enlarged deduction cushions the loss.This paper argues that the conventional view is mistaken. Investors generally will be unable to increase their investments to compensate for the tax, implying that the government collects revenue to the extent returns to risk-bearing are positive. Apparently contrary results derived in the general equilibrium literature are due to the unrelated (and generally unwarranted) assumption that the government operates under a budget constraint incompatible with its retention of revenues from the tax on risky returns. The argument is significant in light of the important ramifications of the conventional view.

An Alternative and User Friendly Algorithm for the Calibration of Complex DSGE Models

The aim of the following paper is to present a derivative based algorithm, which is able to solve calibration problems for complicated DSGE models. Our algorithm is based on considerations that were mainly done during the 80s, when the computable applied general equilibrium (CAGE) literature began to develop models that could no longer be solved analytically. To solve the resulting problem, researchers began to explore the field of homotopy algorithms. With the rise of the dynamic stochastic general equilibrium (DSGE) models, however, the focus began to shift away from these methods, since the determination of the steady state values for the early DSGE models could be done by hand. Nowadays, as the DSGE models get richer and solutions techniques more advanced, these methods come again to the fore. The usage of complicated frictions in a model that additionally features a fully-fledged banking sector forms on the one hand a brilliant framework for modern policy advice. But on the other hand, it is a complicated mathematical construction, which can in many cases no longer be solved analytically. Since these models start to get more influential, new algorithms need to be developed that can support the researcher in the calibration of those models. Such an algorithm is developed in this paper.

Equity Returns and Business Cycles in Small Open Economies

This is the first paper in the dynamic stochastic general equilibrium literature to match key business cycle moments and long-run equity returns in a small open economy with production. These results are achieved by introducing four modifications to a standard real business cycle model: (i) borrowing and lending costs are imposed to increase the volatility of the marginal rate of substitution over time, (ii) capital adjustment costs are assumed to make equity returns more volatile, (iii) GHH preferences are employed to smooth consumption, and (iv) a working capital constraint to generate countercyclical trade balances. Our results are based on data from Argentina, Brazil, and Chile.

The Regional Economic Impacts of Biofuels: A Review of Multisectoral Modelling Techniques and Evaluation of Applications

Allan G. J. The regional economic impacts of biofuels: a review of multisectoral modelling techniques and evaluation of applications, Regional Studies. The regional economic impact of biofuel production depends upon a number of interrelated factors: the specific biofuels feedstock and production technology employed; the sector's embeddedness in the rest of the economy, through its demand for local resources; and the extent to which new activity is created. These issues can be analysed using multisectoral economic models. Some studies use input–output (IO) and social accounting matrix (SAM) modelling frameworks, whilst a nascent computable general equilibrium (CGE) literature has begun to examine the regional impact of biofuel development. This paper reviews, compares and evaluates these approaches for modelling the regional economic impacts of biofuels.

Mobility, housing markets, and schools: Estimating the effects of inter-district choice programs

In theoretical models of residential sorting, a household's location decision is closely linked to its demand for local public services, such as schooling. Since school choice programs weaken the link between residential location and schooling options, they have the potential to affect both property values and residential location choices. Results derived from computable general equilibrium models suggest these effects could be large, but there is limited empirical evidence concerning whether they actually occur. This paper develops and tests predictions concerning the impact of inter-district choice programs on housing values and residential location decisions. Our empirical results strongly confirm our theoretical predictions and the findings of the computable general equilibrium literature: after their states adopt inter-district choice programs, districts with desirable nearby, out-of-district schooling options experience relatively large increases in housing values, residential income, and population density.

Constrained Efficiency in the Neoclassical Growth Model With Uninsurable Idiosyncratic Shocks

We investigate the welfare properties of the one-sector neoclassical growth model with uninsurable idiosyncratic shocks. We focus on the notion of constrained efficiency used in the general equilibrium literature. Our characterization of constrained efficiency uses the first-order condition of a constrained planner's problem. This condition highlights the margins of relevance for whether capital is too high or too low: the factor composition of income of the (consumption-)poor. Using three calibrations commonly considered in the literature, we illustrate that there can be either over- or underaccumulation of capital in steady state and that the constrained optimum may or may not be consistent with a nondegenerate long-run distribution of wealth. For the calibration that roughly matches the income and wealth distribution, the constrained inefficiency of the market outcome is rather striking: it has much too low a steady-state capital stock.

Portfolio Home Bias and External Habit Formation

This paper explores international portfolio choice in a multi-country, multi-good general equilibrium setting which features time-varying risk aversion generated by external habit formation. It is shown that time variation in conditional risk aversion generates time variation in the countries' relative consumption expenditure. As a result, financing equilibrium consumption entails hedging against adverse fluctuations in risk aversion. In equilibrium, an increase in home risk aversion tends to appreciate the home equity and depreciate the foreign equity, so each agent hedges by shifting her equity portfolio towards the home equity claim. Furthermore, the model is able to generate realistic asset price and exchange rate dynamics, satisfying a long-standing need of the general equilibrium literature in international finance.

Can trade costs in goods explain home bias in assets?

A debate has raged in the general equilibrium literature on the impact of trade costs on portfolio home bias. In all of these models there is a simple, easily observed covariance–variance ratio. We compute this term using data on real exchange rates and asset returns. The resulting portfolio home bias is close to zero, implying that GE models that create home bias through trade costs are not grounded in empirical reality. Our results enable the GE literature to move forward, but in a way in which the theoretical models are not at odds with an easily observed empirical regularity.

Asset pricing with dynamic programming

The study of asset price characteristics of stochastic growth models such as the risk-free interest rate, equity premium, and the Sharpe-ratio has been limited by the lack of global and accurate methods to solve dynamic optimization models. In this paper, a stochastic version of a dynamic programming method with adaptive grid scheme is applied to compute the asset price characteristics of a stochastic growth model. The stochastic growth model is of the type as developed by [Brock and Mirman (1972), Journal of Economic Theory, 4, 479–513 and Brock (1979), Part I: The growth model (pp. 165–190). New York: Academic Press; The economies of information and uncertainty (pp. 165–192). Chicago: University of Chicago Press. (1982). It has become the baseline model in the stochastic dynamic general equilibrium literature. In a first step, in order to test our procedure, it is applied to this basic stochastic growth model for which the optimal consumption and asset prices can analytically be computed. Since, as shown, our method produces only negligible errors, as compared to the analytical solution, in a second step, we apply it to more elaborate stochastic growth models with adjustment costs and habit formation. In the latter model preferences are not time separable and past consumption acts as a constraint on current consumption. This model gives rise to an additional state variable. We here too apply our stochastic version of a dynamic programming method with adaptive grid scheme to compute the above mentioned asset price characteristics. We show that our method is very suitable to be used as solution technique for such models with more complicated decision structure.

Bank Competition, Agency Costs, and the Performance of the Monetary Policy

This paper extends the general equilibrium literature on bank competition to evaluate its role on the performance of monetary policy. A new formulation of a financial contract considering market power by banks and costly state verification is proposed. Numerical simulations parameterized to Brazil are performed. The main conclusions are: (1) Greater bank competition or better verification technology enhance the response of the real economy and reduce the reaction of both the default rate and the bank interest spread to an interest rate shock; and (2) The influence of the verification technology is greater when banks operate under perfect competition.

Constrained Efficiency in the Neoclassical Growth Model with Uninsurable Idiosyncractic Shocks

We investigate the welfare properties of the one-sector neoclassic growth model with uninsurable idiosyncratic shocks. We focus on the constrained efficiency notion of the general equilibrium literature, and we demonstrate constrained inefficiency for our model. We provide a characterization of constrained efficiency that uses the first-order condition of a constrained planner's problem that points to the margins of relevance for whether capital is too high or too low: the income composition of the (consumption-)poor. We calibrate our benchmark model parameters governing idiosyncratic risks to the U.S. earnings and wealth distribution, and for this distribution the income of the poor is mainly composed of labor earnings. We compute the constrained-efficient allocations - including transition dynamics - for our model economy, and we conclude that the long-run capital stock in a laissez-faire world is not only too low, but much too low. We also show that one can find parameterizations with different qualitative features: in one case, the steady-state capital stock is too high, and in another case no steady state exists.

Imperfect Labor Mobility and Unemployment in LDCs

In the two-sector, two-factor general equilibrium literature, generic unemployment has been introduced under the assumption of decreasing returns to scale in production (see e.g., Batra and Seth [1, 295-306], and Yu [10, 399-404]), whereas sector-specific unemployment has been introduced under the assumption of sticky wages (e.g., Harris and Todaro [6, 136-42], Corden and Findlay [5, 59-78], Khan [8, 527-47], and Marjit [9, 527-47]). In either case, however, labor is assumed to be perfectly mobile between two sectors. The latter assumption has recently been a major topic of further research in the two-sector general equilibrium literature. Specifically, it is argued that in a perfectly competitive environment, despite significant intersectoral wage differential caused by various parametric policy changes, enough labor do not move from the low wage to the high wage sector to equate the wage rates in two sectors even in the long run. Locational preferences, attachment to existing arrangements, and also the high costs of relocation are usually cited as the possible reasons behind the sluggish movement of labor from one sector to the other. Casas [2, 747-61], in a pioneering article, has modeled this phenomenon of general immobility of labor in a standard two-sector model of production. In his model, however, Casas assumes full employment of labor. The purpose of the present paper is to extend the Casas model further by incorporating unemployment caused by sector-specific sticky wages of the Harris-Todaro variety, and examine the effects of growth and trade policies on output, employment, and welfare of a small country. We will highlight the role of the elasticity of labor mobility parameter in our main results, and demonstrate that there exists a critical (minimum) value of the elasticity of labor mobility parameter that will ensure the validity of the conventional results even in the world of imperfect labor mobility. Several interesting results emerge from our analysis. In particular, we have shown that capital accumulation causes urban unemployment to rise and the optimal tariff for a small open economy is positive. The paper is organized as follows. In section II, we lay out the basic model of labor immobility and unemployment; and in section III we derive the basic comparative static results. In

Financial Market Innovation and Security Design: An Introduction

The article describes, in the context of theory and practice, this special issue of the Journal of Economic Theory on financial market innovation and security design. The main focus is on security design in incomplete financial markets, possibly with asymmetrically informed traders. We first survey the general equilibrium literature, which emphasizes the spanning role of securities. We then provide a unified framework encompassing the literature that employs a CARA-Guassian setting to study the impact of financial innovation on risk-sharing and information aggregation. Journal of Economic Literature Classification Numbers G10, D52.

Macroeconomic adjustment and inconvertible currencies in the third world

In 1987, Zimbabwe experienced serious difficulties in expanding mineral production, notably gold, due to a shortage of foreign exchange for the importation of spare parts and mining equipment ["Zimbabwe Survey," 1987]. Since gold can easily be converted into foreign currency, this may seem rather startling and paradoxical on a superficial level. Foreign exchange production declined as a result of a foreign exchange shortage. Similarly, in 1979, a World Bank Program loan was used to fmance the foreign exchange requirements of Jamaica's export industries. In theory, the profitable production of exports should generate more foreign exchange than it requires. The World Bank loan should have been completely unnecessary ['Report and Recommendation, ~ 1979]. Throughout the Developing World, there are many more examples of such self-perpetuating foreign exchange shortages. Often such countries undergo what is known in the local press as a "foreign exchange crisis:" a catastrophic collapse of the economy's ability to maintain the flow of essential imports resulting in draconian trade and exchange controls. Although terms of trade fluctuations or disturbances in world markets may play a role, "foreign exchange crises" typically arise when governments allow their domestic currencies to become seriously overvalued but resist devaluation because they feel that it will fan the flames of inflation. For a period of time, external borrowing or reserve depletion can maintain import levels, but sooner or later these wells run dry. Then the government must resort to foreign exchange or import controls if the authorities still cannot accept a devaluation. This creates a new foreign exchange regime-one where quotas are used to reduce import levels to the available supply of foreign exchange. Because such regimes involve a fixed exchange rate at which the Central Bank buys foreign exchange and sells rationed amounts of foreign exchange, they can be confused with standard, fixed exchange rate regimes. But there is a vital difference between these two types of regimes. Under a standard, fixed rate regime, the Central Bank buys and sells foreign exchange to equilibrate the supply and demand for foreign exchange. By contrast, in an import control regime, the Central Bank does not have usable foreign exchange reserves to sell. It must ration imports in order to reduce the level of demand for foreign exchange. Many attempts to model the effects of import controls, such as Occampo [1987] are not as useful as they first appear because they treat import controls as exogenous, rather than determining the quotas as a result of foreign exchange availability. Consequently, they are not true general equilibrium models. Although they are common in the Third Wodd, there is little good general equilibrium literature on this topic. McKinnon [1979, p. 440], in a review of the multiple volume NBER study, Foreign Trade Regimes and Economic Development, headed by Bhagwati and Krueger, pointed out that "Devaluation in the presence of exchange controls and other QRs has not been well worked out in

Security Markets: Stochastic Models

Most modern financial research can be characterized as theoretical or empirical, or a mix of the two. Theoretical finance can be divided in the way that theoretical economics is. Neoclassical research stems from the neoclassical economics of perfectly competitive markets that have no imperfections or frictions, such, as taxes, transaction costs, externalities, or information asymmetries. By definition, imperfect markets research includes all other topics, such as the study of taxes, institutions, and topics stemming from information economics. Darrell Duffie's new book is an introduction to neoclassical finance that emphasizes topics in the intersection of theoretical finance and the mathematical economics of general equilibrium. The book is designed to take the student from first principles to the frontiers of finance-oriented general equilibrium theory. The book contains a rigorous introduction to the necessary topics in probability and stochastic control and is a good source for that material. It also contains a good summary of general equilibrium theory, including the required background mathematics. Each theorem from the general equilibrium literature is presented in a form that is general enough to be applicable to continuous-time models in finance but is as simple as possible given that level of generality. Other variations are mentioned in the literature reviews at the end of each section.

THE TRANSFORMATION FUNCTION REVISITED

Introduction The transformation function for two‐sector production models has been used extensively in the international trade and general equilibrium literature. It has been derived both graphically and mathematically from individual sector production functions that are assumed to be linearly homogeneous. The result has been a convex set possessing first derivatives that have frequently been used. However, there seems to be a lack of research on further properties attributable to the transformation function. The purpose of this paper is to analyze these additional properties. We begin by proving that the transformation function is linearly homogeneous in all of its arguments. We then derive the standard first derivatives of the transformation function providing their usual economic interpretation. Finally, we conclude by deriving and interpreting the second‐order derivatives of the transformation function.