We study a variant of the one-sector neoclassical growth model of Diamond in which capital investment must be credit financed, and an adverse selection problem appears in loan markets. The result is that the unfettered operation of credit markets leads to a one-dimensional indeterminacy of equilibrium. Many equilibria display economic fluctuations which do not vanish asymptotically; such equilibria are characterized by transitions between a Walrasian regime in which the adverse selection problem does not matter, and a regime of credit rationing in which it does. Moreover, for some configurations of parameters, all equilibria display such transitions for two reasons. One, the banking system imposes ceilings on credit when the economy expands and floors when it contracts because the quality of public information about the applicant pool of potential borrowers is negatively correlated with the demand for credit. Two, depositors believe that returns on bank deposits will be low (or high): these beliefs lead them to transfer savings out of (into) the banking system and into less (more) productive uses. The associated disintermediation (or its opposite) causes banks to contract (expand) credit. The result is a set of equilibrium interest rates on loans that validate depositors' original beliefs. We investigate the existence of perfect foresight equilibria displaying periodic (possibly asymmetric) cycles that consist of m periods of expansion followed by n periods of contraction, and propose an algorithm that detects all such cycles.
We examine the conditions under which steady states with low real interest rates—real rates substantially below the output growth rate—exist in an overlapping generations model with production, capital accumulation, a labor-leisure trade-off, technological progress, and agents who live for many periods. The number of periods in an agent's life (n) is left open for much of the analysis and determines the temporal interpretation of a time period. The qualitative properties of the model are largely invariant to different values of n. We find that two low real interest rate steady states exist for empirically plausible values of the parameters of the model. Outside liabilities such as fiat currency or unbacked government debt are valued in one of these steady states.
This paper develops a simple model of sovereign debt in which defaulting nations are excluded from capital markets and regain access by making partial repayments. This is consistent with the historical evidence that defaulting countries return to international loan markets soon after a settlement, but after varying periods of exclusion.
Over the past decade, a substantial literature on the estimation of discrete choice dynamic programming (DC-DP) models of behavior has developed. However, this literature now faces major computational barriers. Specifically, in order to solve the dynamic programming (DP) problems that generate agents' decision rules in DC-DP models, high dimensional integrations must be performed at each point in the state space of the DP problem. In this paper we explore the performance of approximate solutions to DP problems. Our approximation method consists of: 1) using Monte Carlo integration to simulate the required multiple integrals at a subset of the state points, and 2) interpolating the non-simulated values using a regression function. The overall performance of this approximation method appears to be excellent, both in terms of the degree to which it mimics the exact solution, and in terms of the parameter estimates it generates when embedded in an estimation algorithm.
This paper catalogues formulas that are useful for estimating dynamic linear economic models. We describe algorithms for computing equilibria of an economic model and for recursively computing a Gaussian likelihood function and its gradient with respect to parameters. We display an application to Rosen, Murphy, and Scheinkman's (1994) model of cattle cycles.
In 1985–86 the authors were members of a team that constructed a static applied general equilibrium model that was used to analyze the impact on the Spanish economy of the 1986 fiscal reform, which accompanied Spain’s entry into the European Community. This paper compares the results obtained to recently published data for 1985–87; we find that the model performed well in predicting the changes in relative prices and resource allocation that actually occurred, particularly if we incorporate exogenous shocks that affected the Spanish economy in 1986. We also analyze the sensitivity of the results to alternative specifications of the labor market and macroeconomic closure rules; we find that the central results are robust.
Applied general equilibrium models with imperfect competition and economies of scale have been extensively used for analyzing international trade and development policy issues. They offer a natural framework for testing the empirical relevance of propositions from the industrial organization and new trade theoretical literature. This paper warns model builders and users that considerable caution is needed in interpreting the results and deriving strong policy conclusions from these models: in this generation of applied general equilibrium models, nonuniqueness of equilibria is not a theoretical curiosum, but a potentially serious problem. Disregarding this may lead to dramatically wrong policy appraisals.