Topics in Dynamic Macroeconomics

Field: Economics, Econometrics and Finance (Social Sciences)

In chapter 1, I provide a new model to study the consumption-saving decision in the presence of permanent income risk. It is an extension of the classical Aiyagari model. Aiyagari style economies are a workhorse model of quantitative research. For this economy, I prove the existence of a recursive competitive equilibrium and show that there exist equilibria where borrowing constraints are never binding. This allows me to establish a non-trivial lower bound on the equilibrium interest rate. To solve the individual consumption-saving problem, I present a new approach that uses lattices of consumption functions to deal with the non-compact state space and the unbounded utility function of the problem. The approach uses only the first order conditions of the problem (Euler equations). The proof is constructive and it serves as a theoretical foundation for the convergence of a policy function iteration procedure.\n\nChapter 2 uses the model presented in chapter 1 for a quantitative analysis. The paper builds on the existing results that in models with transitory income shocks and trade in a riskless asset the welfare loss of missing insurance markets is small, and that with permanent income shocks and no trade in assets the welfare losses can become substantial. I consider an empirically relevant case in between the two extreme cases with permanent income shocks but trade in a riskless asset. I show that welfare losses from missing insurance markets in this model are still substantial. Furthermore, I show that one can closely align the welfare effects in a model without asset trade to the welfare effects in a model with asset trade by scaling the volatility of income uncertainty. I derive a scaling factor that coincides with the labor income share of total income and provide a closed form approximation formula to describe the welfare costs of permanent income shocks in the presence of market incompleteness and self-insurance. From these findings, I conclude that asset trade provides an effective channel for self-insurance also in models with permanent income shocks.\n\n\nIn chapter 3, that is joint work with Philip Jung, we document that the firing rate volatility in Germany is 2.5 times as high as in the U.S. and contributes 60 - 70 % to the aggregate unemployment volatility, the opposite of what is found for the US. We show that wage rigidities are not at the root of these large differences. To explain the cross-country differences, we develop a labor market search model with endogenous firings, quits on the job, and match heterogeneity. We calibrate the model for Germany and the US jointly to study the institutional differences that generate the differences in business cycle behavior. We show that the model predicts the observed time-series pattern of important labor market variables for both countries well. We show that institutional differences generating lower average hiring and firing rates amplify the response of the economy to aggregate shocks. At the same time, they are responsible for substantial differences in the persistence of the unemployment rate, explaining the sluggish response to shocks in Germany compared to the US.\n