A Child’s Guide to Dynamic Stochastic General Equilibrium Models
•Micro behavior everyone agrees on:•Agent’s behavior doesn’t change when policy changes•Overcomes Lucas Critique
•Forward – looking agents Dynamic•Agents impacted by shocks Stochatic•The agents: households and firms General•Constraints are respected Equilibrium
The Global Great Depression: A Real Business Cycle? Review of Economic Dynamics, January 2000
1
Great Depressions of the 20th Century Pages 1-18 Timothy J. Kehoe, Edward C. Prescott
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2
The Great U.K. Depression: A Puzzle and Possible Resolution Original Research Article Pages 19-44 Harold L. Cole, Lee E. Ohanian
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3
The Great Depression in Canada and the United States: A Neoclassical Perspective Original Research Article Pages 45-72 Pedro S. Amaral, James C. MacGee
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4
The French Depression in the 1930s Original Research Article Pages 73-99 Paul Beaudry, Franck Portier
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5
The Role of Real Wages, Productivity, and Fiscal Policy in Germany's Great Depression 1928–1937 Original Research Article Pages 100-127 Jonas D. M. Fisher, Andreas Hornstein
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6
The Great Depression in Italy: Trade Restrictions and Real Wage Rigidities Original Research Article Pages 128-151 Fabrizio Perri, Vincenzo Quadrini
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7
Argentina's Lost Decade Original Research Article Pages 152-165 Finn E. Kydland, Carlos E. J. M. Zarazaga
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The German Slump as a Real Business CycleRational expectations Real business cycles (RBC)
•Dynamic (Stochastic) General Equilibrium Growth Model•DSGE applied to short-run fluctuations to explain Great Depression by Fisher and Hornstein
•Representative agents weigh future utility when deciding how much to work and how much to save/invest at present•They ignore monetary impacts … “Money lagged output”•Recall Voth: lower interest rate might have stimulated investment, output and employment
•A Major critique of RBC-theory – the Great Depression•Lucas/Prescott: Gone fish’n’ ???
•German slump: Hoffmann data Ritschl data•8 – hour day: a productivity shock
P
Y
AS
AD
Observed fluctuations must be owing to AS shocks• Factor inputs and productivity• “Intertemporal” labor-leisure substitution
Fisher – Hornstein: DGE model of Germany, 1928-37 • All per capita variables relative to real gdp trend (in equilibrium, they should grow at
same rate)• Measure total factor productivity (TFP) as Solow residual:
Y = A Kα L(1- α) dA/A = TFP growth = dY/Y – α dK/K – (1 - α) dL/L• Ignore M1 … it lagged Y• Output determined by Cobb-Douglas production function
Y = A k.25 [γtn].75 • Labor share of income averaged ¾ • Technology advanced at 1.87% annual rate (γ)
– Profit maximizing firm hires factors (n and x) so MPL = w and MPK = r
Note• Wages set by collective bargaining and arbitration
Political Wage Wages too High? (Borchardt)• Bruening austerity policy...he raised taxes and cut spending • Nazis broke unions (1933) – set maximum wages and limited mobility
Bruening lowered civil servant wages and tried to reduce private sector wages• Nazi expansion with limits to consumption
Military Keynesianism?
Fisher – Hornstein Simulations
• Response of employment, output, consumption, investment and real wage to alternative values of productivity (trend or actual), fiscal policy (trend or actual), and real wage (market clearing or actual)
I – Actual productivity with trend fiscal stance and market clearing wageReal wage should have declined to clear labor market, not risen, in early years of German depression
II – Actual fiscal policy with trend TFP and market clearing real wagePredict not nearly as much contraction of employment, output, consumption and investment as actually occurred from 1928 – 1932.
III – Actual real wage with trend TFP and actual fiscal policyPredict less reduction in consumption than actually occurred … but otherwise generate patterns close to actual
Combinations of actual real wages, Bruening fiscal austerity followed by Nazi expansion, and actual TFP trace decline in investment, output and employment but fail to predict sharp decline in consumption in downturn and failure to recover in upturn.
»More research is called for.
German Interwar Economic Pathologies: An Overview Lost War and Revolution Distributional Conflict
+ 8 – Hour Day Desperate Government
HyperinflationStabilization
Monetary Constraints Outsized WagesReduced Investment Depression and SlumpNazi Revolution/Constraints Broken Wages Down Government Spending Up (military Keynesianism) “Recovery”
