EC8723 Discussion1b Jan9

BALANCED GROWTH PATH IN LABOR
SEARCH AND MATCHING MODEL
JANUARY 9, 2017
Introduction
CALIBRATION – PHILOSOPHY
 An economic model is a measuring device
 If model makes “believable” predictions along some important dimensions

(i.e., “matches some key data”)…
 …then maybe its predictions are “believable” along the novel dimensions of
the model
 Getting some “partial derivatives” of the model in known directions

correct…
 …may build credibility that its “partial derivatives” in novel directions are at
least not grossly incorrect
 Make model match some data of interest – often long-run (i.e., time-
averaged data) growth facts
 Preferably well-accepted “stylized facts”
 Solow growth model in the background
 Natural candidate: Kaldor growth facts
 Calibration vs. Estimation
January 9, 2017 3
Introduction
CALIBRATION OF BASELINE RBC MODEL

 Must take a stand on three (related) points
 Which data do we want model to match? (even constructing data is challenging…)
 Functional forms (utility, production)
 Parameter values
 Choose functional forms consistent with “Kaldor-plus facts”

 (K1) Capital income share and labor income share of GDP are stationary
 (K2) All real quantity variables grow at same rate in the long run (“great ratios”)
 (K3) Real interest rate is stationary
 (K4) Hours per worker are stationary
 (K5) (K2) requires trend productivity to be labor-augmenting (Phelps 1966)
January 9, 2017 4
Introduction


 Often start with RBC model that abstracts from long-run growth
 But “true” calibration begins with model featuring only long-run growth
 Puts restrictions on instantaneous utility and production forms
 Use (K1)-(K5) to obtain these restrictions
January 9, 2017 5
Introduction


 Often start with RBC model that abstracts from long-run growth
 But “true” calibration begins with model featuring only long-run growth
 Puts restrictions on instantaneous utility and production forms
 Use (K1)-(K5) to obtain these restrictions
 Richer models: more calibration targets and/or treating data differently

 Monopoly markups (e.g., Dixit-Stiglitz and sticky price models)
 Probability of finding a job (e.g., labor matching models)
 Durable consumption vs. non-durable consumption
January 9, 2017 6
Calibration of Search Model with Growth
SEARCH MODEL WITH GROWTH

 Absent shocks, TFP grows at deterministic rate γ
Trend productivity is labor-
 Planner problem/perfect competition augmenting (Harrod-neutral)

(Makes use of fact (K5))
max E0 bt u (Ct , lfpt ) subject to
t 0
Ct  K t 1  (1   ) K t  t  vt  zt F ( K t , nt X t ) Flow resource constraint
Red indicates variables or
parameters that will be modified nt  (1   ) nt 1  m(lfpt  (1   )nt 1 , vt ) Aggregate LOM of labor
when detrending the model
X t 1   t X t ,  1 Evolution of deterministic
component of productivity
given stochastic process for evolution of zt and (K-1, n-1, z0, X0)
January 9, 2017 7
SEARCH MODEL WITH GROWTH

 Absent shocks, TFP grows at deterministic rate γ
Trend productivity is labor-
 Planner problem/perfect competition augmenting (Harrod-neutral)

(Makes use of fact (K5))
max E0 bt u (Ct , lfpt ) subject to
t 0
Ct  K t 1  (1   ) K t  t  vt  zt F ( K t , nt X t ) Flow resource constraint
Red indicates variables or
parameters that will be modified nt  (1   ) nt 1  m(lfpt  (1   )nt 1 , vt ) Aggregate LOM of labor
when detrending the model
X t 1   t X t ,  1 Evolution of deterministic
component of productivity
given stochastic process for evolution of zt and (K-1, n-1, z0, X0)
 Suppose zt = 1 always, so only deterministic growth

 Deterministic dynamics of (Ct, Kt+1, lfpt, nt, vt, Xt) governed by
ulfp (Ct , lfpt ) ms ( st , vt ) Labor supply t Labor demand
(1)   t   X t F2 ( K t , nt X t ) function
uC (Ct , lfpt ) mv ( st , vt ) function mv ( st , vt )
uC (Ct , lfpt ) Capital supply  bu (C , lfp )   1  ms ( st 1 , vt 1 ) 
(2)  F1 ( K t 1 , nt 1 X t 1 )  1   function  (1   )  c t 1 t 1   t 1
buC (Ct 1 , lfpt 1 ) (3)  uc (Ct , lfpt )  mv ( st 1 , vt 1 )
(4) Ct  K t 1  (1   ) K t  t  vt  F ( K t , nt X t )
(6) X t 1   t X t
Normalize
(5) nt  (1   )nt 1  m( st , vt ) LOM of labor
X0 = 1
January 9, 2017 8
RESTRICTIONS ON FUNCTIONAL FORMS

ulfp (Ct , lfpt ) ms ( st , vt ) t
(1)   t  (3)  X t F2 ( K t , nt X t )
uC (Ct , lfpt ) mv ( st , vt ) mv ( st , vt )
uC (Ct , lfpt )  bu (C , lfp )   1  ms ( st 1 , vt 1 ) 
(2)  F1 ( K t 1 , nt 1 X t 1 )  1    (1   )  C t 1 t 1   t 1
buC (Ct 1 , lfpt 1 )  uC (Ct , lfpt )  mv ( st 1 , vt 1 )
(4) Ct  K t 1  (1   ) K t  t  vt  F ( K t , nt X t ) (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t
January 9, 2017 9

(1)   t  (3)  X t F2 ( K t , nt X t )
uC (Ct , lfpt )  bu (C , lfp )   1  ms ( st 1 , vt 1 ) 
(2)  F1 ( K t 1 , nt 1 X t 1 )  1    (1   )  C t 1 t 1   t 1
buC (Ct 1 , lfpt 1 )  uC (Ct , lfpt )  mv ( st 1 , vt 1 )
(4) Ct  K t 1  (1   ) K t  t  vt  F ( K t , nt X t ) (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t
And viewing economic profits as zero
 F ( K , nX )  K  (nX )1 (  0.4)
January 9, 2017 10

(1)   t  (3)  X t F2 ( K t , nt X t )
 bu (C , lfp )   1  ms ( st 1 , vt 1 ) 
 1
uC (Ct , lfpt )  K / X t 1 
(2)    t 1  1   (1   )  C t 1 t 1   t 1
buC (Ct 1 , lfpt 1 )  nt 1   uC (Ct , lfpt )  mv ( st 1 , vt 1 )
(4) Ct  K t 1  (1   ) K t  t  vt  K t  nt X t 
1
(5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t
January 9, 2017 11

(1)   t  (3)  X t F2 ( K t , nt X t )
 bu (C , lfp )   1  ms ( st 1 , vt 1 ) 
 1
uC (Ct , lfpt )  K / X t 1 
(2)    t 1  1   (1   )  C t 1 t 1   t 1
1
(5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t
 (K2) All real (goods-denominated…) quantity variables grow at same rate in

the extremely long run
Yt 1 Ct 1 K t 1 t 1 X t 1
     , t
Yt Ct Kt t Xt
Yt Kt Ct 
 yt   y, kt   k, ct   c , t  t = t
Xt Xt Xt Xt
January 9, 2017 12


ulfp (Ct , lfpt ) m (s , v ) t  K / X t  Recall F(.) is CRS
(1)   t  s t t (3)  (1   ) X t  t 
uC (Ct , lfpt ) mv ( st , vt ) mv ( st , vt )  nt 
 1
(2) uC (Ct , lfpt )  K / X t 1 
   t 1 1   bu (C , lfp )   1  ms ( st 1 , vt 1 ) 
  (1   )  C t 1 t 1   t 1
1
(5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t
 Scale (1), (3), and (4) by Xt to write in stationary form


ulfp (Ct , lfpt ) m (s , v ) (3) t k 
(1)   t  s t t  (1   )  t 
 bu (C , lfp )    1  ms ( st 1 , vt 1 ) 
uC (Ct , lfpt ) k 
 1   t  (1   )  C t 1 t 1   t 1
(2)    t 1  1   uC (Ct , lfpt )  mv ( st 1 , vt 1 )
buC (Ct 1 , lfpt 1 )  nt 1 
(4) ct   t kt 1  (1   )kt    vt  kt nt1 (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t
January 9, 2017 13


(1)   t  s t t  (1   )  
 bu (C , lfp )    1  ms ( st 1 , vt 1 ) 
uC (Ct , lfpt )  k 
 1   t  (1   )  C t 1 t 1   t 1
(2)    1   uC (Ct , lfpt )  mv ( st 1 , vt 1 )
buC (Ct 1 , lfpt 1 )  nt 1 
(4) c   t k  (1   )k    vt  k  nt1 (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t
January 9, 2017 14


(1)   t  s t t  (1   )  
 bu (C , lfp )    1  ms ( st 1 , vt 1 ) 
uC (Ct , lfpt )  k 
 1   t  (1   )  C t 1 t 1   t 1
(2)    1   uC (Ct , lfpt )  mv ( st 1 , vt 1 )
buC (Ct 1 , lfpt 1 )  nt 1 
(4) c   t k  (1   )k    vt  k  nt1 (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t
 (K4 – generalized) Time spent in each activity is stationary
along deterministic path.

 lfpt  lfp BUT
and st  s lfp is endogenous…
s is endogenous…
and nt  n
n is endogenous…
 Recall definition: lfpt = (1-ρ)nt-1 + st
January 9, 2017 15


(1)
ulfp (Ct , lfp ) m (s , v ) (3)  k 
  s  (1   )  
uC (Ct , lfp ) mv ( s , v ) mv ( s , v ) n
 bu (C , lfp )    1  ms ( s , v ) 
uC (Ct , lfp) k 
 1   t  (1   )  C t 1 
(2)    1   C t
u (C , lfp )  mv ( s , v )
buC (Ct 1 , lfp ) n
(4) c   t k  (1   )k    vt  k  nt1 (5) n  (1   )n  m( s , v ) (6) X t 1   t X t
 Implied already (RHS of (2)) is

 Final step – functional form for utility?
January 9, 2017 16


(1)
ulfp (Ct , lfp ) m (s , v ) (3)  k 
  s  (1   )  
 bu (C , lfp )    1  ms ( s , v ) 
 1   t  (1   )  C t 1 
(2)    1   C t
u (C , lfp )  mv ( s , v )

 Observations
 Optimal choice of lfp must be independent of Xt (from (1))
 Requires offsetting income and substitution effects of wages (long-run
productivity) on LFP (aka, labor supply)
 IMRS can only depend on Ct+1/Ct (from (2)), which in turn = γt
January 9, 2017 17


(1)
ulfp (Ct , lfp ) m (s , v ) (3)  k 
  s  (1   )  
 bu (C , lfp )    1  ms ( s , v ) 
 1   t  (1   )  C t 1 
(2)    1   C t
u (C , lfp )  mv ( s , v )

 Two requirements together imply
 Ct v(lfpt )1  1 

 if   0,   1
u (Ct , lfpt )   1 
ln C  v(lfp ) if   1 
 t t 
January 9, 2017 18

EC8723 Discussion1b Jan9

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BALANCED GROWTH PATH IN LABOR

SEARCH AND MATCHING MODEL

 If model makes “believable” predictions along some important dimensions

 Getting some “partial derivatives” of the model in known directions

 Calibration vs. Estimation

CALIBRATION OF BASELINE RBC MODEL

 Choose functional forms consistent with “Kaldor-plus facts”

CALIBRATION OF BASELINE RBC MODEL

 Choose functional forms consistent with “Kaldor-plus facts”

CALIBRATION OF BASELINE RBC MODEL

 Choose functional forms consistent with “Kaldor-plus facts”

 Richer models: more calibration targets and/or treating data differently

SEARCH MODEL WITH GROWTH

SEARCH MODEL WITH GROWTH

 Suppose zt = 1 always, so only deterministic growth

RESTRICTIONS ON FUNCTIONAL FORMS

(4) Ct  K t 1  (1   ) K t  t  vt  F ( K t , nt X t ) (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t

RESTRICTIONS ON FUNCTIONAL FORMS

(4) Ct  K t 1  (1   ) K t  t  vt  F ( K t , nt X t ) (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t

 F ( K , nX )  K  (nX )1 (  0.4)

RESTRICTIONS ON FUNCTIONAL FORMS

RESTRICTIONS ON FUNCTIONAL FORMS

 (K2) All real (goods-denominated…) quantity variables grow at same rate in

RESTRICTIONS ON FUNCTIONAL FORMS

 Scale (1), (3), and (4) by Xt to write in stationary form

(4) ct   t kt 1  (1   )kt    vt  kt nt1 (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t

RESTRICTIONS ON FUNCTIONAL FORMS

(4) c   t k  (1   )k    vt  k  nt1 (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t

RESTRICTIONS ON FUNCTIONAL FORMS

(4) c   t k  (1   )k    vt  k  nt1 (5) nt  (1   )nt 1  m( st , vt ) (6) X t 1   t X t

 (K4 – generalized) Time spent in each activity is stationary

along deterministic path.

 Recall definition: lfpt = (1-ρ)nt-1 + st

RESTRICTIONS ON FUNCTIONAL FORMS

(4) c   t k  (1   )k    vt  k  nt1 (5) n  (1   )n  m( s , v ) (6) X t 1   t X t

 Implied already (RHS of (2)) is

 Final step – functional form for utility?

RESTRICTIONS ON FUNCTIONAL FORMS

(4) c   t k  (1   )k    vt  k  nt1 (5) n  (1   )n  m( s , v ) (6) X t 1   t X t

 Implied already (RHS of (2)) is

 Final step – functional form for utility?

RESTRICTIONS ON FUNCTIONAL FORMS

(4) c   t k  (1   )k    vt  k  nt1 (5) n  (1   )n  m( s , v ) (6) X t 1   t X t

 Implied already (RHS of (2)) is

 Final step – functional form for utility?

 Two requirements together imply

 Ct v(lfpt )1  1 

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