Measuring business cycles by saving for a rainy day

By Mario Crucini and Mototsugu Shintani

http://d.repec.org/n?u=RePEc:fip:feddgw:50&r=dge

We propose a simple saving-based measure of the cyclical component in GDP. The measure is motivated by the prediction that the representative consumer changes savings in response to temporary deviations of income from its stochastic trend, while satisfying a present-value budget constraint. To evaluate our procedure, we employ the bivariate error correction model of Cochrane (1994) to the member countries of the G-7 and Australia. Our estimates reveal, that to a close approximation, the stochastic trend component of GDP is consumption and the transitory component is the error correction term, which justifies the use of our saving-based measure.

The HP-filter is a largely atheoretic way to measure cyclical components in the data. The choice of the penalty parameter is somewhat arbitrary, which makes that the cyclical component may include fluctuations that households consider to be permanent or miss fluctuations that are cyclical. Using realized consumption as a yardstick for what the households consider to be permanent fluctuations, this paper may give us a better measure of cyclical components, based on some minimal theory.

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A Dynamic General Equilibrium Approach to Asset Pricing Experiments

By John Duffy and Sean Crockett

http://d.repec.org/n?u=RePEc:pit:wpaper:398&r=dge

We report results from a laboratory experiment that implements a consumption-based dynamic general equilibrium model of asset pricing. This work-horse model of the macrofinance literature posits that agents buy and sell assets for the purpose of intertemporally smoothing consumption, and that asset prices are determined by individual risk and time preferences as well as the distribution of income and dividends. The experimental findings are largely supportive of the model’s theoretical predictions. Notably we observe that asset price bubbles, defined as sustained departures of prices from those implied by fundamentals, are infrequent and short-lived. This finding is a stark departure from many recent multi-period asset pricing experiments that lack a consumption-smoothing objective. Indeed, we find that when subjects are induced to adjust shareholdings to smooth consumption, assets typically trade at a discount relative to their expected value and market participation is broad; when the consumption smoothing motivation to trade assets is removed in an otherwise identical economy, assets frequently trade at a premium relative to fundamentals and shareholdings become highly concentrated.

This is the first work I have seen that takes an experimental approach to DGE, so I would have titled it the other way around. Is this a valid approach to validating DGE models? Could we even calibrate models that way?

The employed, the Unemployed, and the Unemployable: Directed Search with Worker Heterogeneity

Suren Basov, Ian King and Lawrence Uren

http://d.repec.org/n?u=RePEc:ltr:wpaper:1837-2198/978-0-9807041-5-0&r=dge

We examine the implications of worker heterogeneity on the equilibrium matching process, using a directed search model. Worker abilities are selected from a general distribution, subject to some weak regularity requirements, and the firms direct their job offers to workers. We identify conditions under which some fraction of the workforce will be “unemployable”: no firm will approach them even though they offer positive surplus. For large markets we derive a simple closed form expression for the equilibrum matching function. This function has constant returns to scale and two new terms, which are functions of the underlying distribution of worker productivities: the percentage of unemployable workers, and a measure of heterogeneity “kappa”.The equilibrium unemployment rate is increasing in “kappa” and, under certain circumstances, is increasing in the productivity of highly skilled workers, despite endogenous entry. A key empirical prediction of the theory is that “kappa” = 1. We examine this prediction, using data from several countries.

Directed search model are all the rage nowadays, and they are useful, too, in getting some new insights, and this paper shows. For one, it comes up with some sort of reduced form matching function that could be used in other models. It also gives us some better understanding about long-term unemployment or unemployability, something people worry about quite a bit with the current recession and its potentially profound structural changes.