Introduction to Dynamic Macroeconomic General Equilibrium Models

323 Pages·2016·6.47 MB·English

by  José Luis Torres Chacón

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Part I
Introduction to DSGE modelling
Part II
Deviations from the Permanent Income-Life Cycle hypothesis
Part III
Investment and Capital
Accumulation
Part IV
The government
Part V
Time Decisions
Part VI
Imperfect competition
Preface
To Anelí and Carla
Dynamic General Equilibrium (DGE) models have become the fundamental tool
in current macroeconomic analysis. Static models and partial equilibrium
macroeconomic models could be useful in some applications but they are of
limited value to study how the economy as a whole responds to a particular
shock. The widespread use of DGE models in modern macroeconomic analysis
reflects their usefulness as a “macroeconomic laboratory” that allow us to
analyze how economic agents respond to changes in their environment, in a
dynamic general equilibrium micro-founded theoretical setting in which all
endogenous economic variables are determined simultaneously. Notwithstanding
the approach’s important shortcomings, DGE models are now in common use
everywhere, from academic research to Central Banks and other public and
private economic institutions. Though these models are probably too aggregated
and include an awful lot of assumptions about the real world that are clearly too
simplistic, they can be very useful to help understand some of the dynamics
driving the economy.
This book offers an introductory step-by-step course to Dynamic Stochastic
General Equilibrium (DSGE) modelling. Modern macroeconomic analysis is
increasingly concerned with the construction, calibration and-or estimation, and
simulation of DSGE models. DSGE models start from what we call the micro-
foundations of macroeconomics, with a heart based on the rational expectation
forward-looking economic behavior of agents. The book is intended for graduate
students as an introductory course to DSGE modelling and for those economists
who would like a hands-on approach to learning the basics of modern dynamic
macroeconomic modelling. While theoretical developments are not too complex
to understand for the beginner in this topic, practical applications to the data is
usually a more difficult task. Taking models to the data is now fortunately easier
thanks to the development of specific DSGE modelling computer software. Once
the theoretical model is on hands and the functions are parameterized, the next
step is its application to the data. The usual procedure consists in the calibration
of the parameters of the model using previous information or matching some key
ratios or moments provided by the data, or more recently, from the estimation of
the parameters using maximum likelihood or Bayesian techniques. Taking model
to the data is a major barrier of entry that has to be paid by those who want to
to the data is a major barrier of entry that has to be paid by those who want to
incorporate this state-of-the-art tool into their economic analysis. DSGE models
cannot be solved analytically, except some very simple and unrealistic examples
of limited interest. This is not a book about solution methods neither about
estimation techniques.
The book starts with the simplest canonical neoclassical DSGE model and
then gradually extends the basic framework incorporating a variety of additional
features, such as consumption habit formation, non-Ricardian agents, investment
adjustment costs, investment-specific technological change, taxes, public
spending, public capital, human capital, household production, and monopolistic
competition. All these additional features are introduced in the standard DSGE
model separately in order to clearly identify the effects of each additional feature
whereas keeping the model as simple as possible.
At the end of each chapter associated Dynare code is included with the
model to be implemented in Matlab or Octave. Dynare is a very useful and
powerful tool to deal with DSGE modelling. With the supply of minimal
information regarding the calibration of the parameter and the equilibrium
equations of the model, Dynare can solve a DSGE model, compute the steady
state and carry out stochastic simulations of shocks in a very simple way. Dynare
codes can also be downloaded from the book’s homepage:
http://www.vernonpress.com/title.php?id=18
Finally, I would like to thank Dimitris Pontikakis, Gonzalo F-de-Córdoba,
Jesús Rodríguez, Noelia Fernández and graduate students at the University of
Málaga and University Pablo de Olavide (Seville), for their helpful comments
and corrections of earlier versions of this book.
José L. Torres
Faraján (Málaga), January 2014
Contents
I Introduction to DSGE modelling
1 Introduction
1.1 Macroeconomic DSGE Modelling
1.2 DSGE software
1.3 Book organization
2 The Canonical Dynamic Macroeconomic General Equilibrium model
2.1 Introduction
2.2 Households
2.2.1 Alternative functional forms for the utility function
2.3 The firms
2.3.1 Alternative functional forms of the production function
2.4 Model Equilibrium
2.4.1 Model Equilibrium (Competitive Equilibrium)
2.4.2 Model Equilibrium (Central Planning)
2.5 The Steady State
2.6 The Dynamic Stochastic General Equilibrium model
2.7 Equations of the model and calibration
2.7.1 Equilibrium equations
2.7.2 Calibration
2.8 Aggregate productivity shock
2.9 Conclusions
II Deviations from the Permanent Income-Life Cycle hypothesis
3 Habit Formation
3.1 Introduction
3.2 Habit formation
3.3 The model
3.3.1 Households
3.3.2 The firms
3.3.3 Equilibrium