Where is the GE? Consumption Dynamics in DSGEs

• Published date: 01 September 2019
• Author: JEAN‐PAUL L'HUILLIER,DONGHOON YOO
• Date: 01 September 2019
• DOI: http://doi.org/10.1111/jmcb.12570

DOI: 10.1111/jmcb.12570

JEAN-PAUL L’HUILLIER

DONGHOON YOO

Where is the GE? Consumption Dynamics

in DSGEs

We offer a partial equilibrium perspectiveon the behavior of consumption

in dynamic stochastic general equilibrium (DSGE) models. We consider a

benchmark dynamic general equilibrium model and show that a standard

calibration implies that the real interest rate is essentially fixed. One man-

ifestation of this feature is that, with separable preferences, the reaction of

consumption to total factor productivity (TFP) shocks is flat: the random-

walk permanent income hypothesis holds almost exactly, pretty much as

in a partial equilibrium consumption-savings problem. These results help

explain the prominent role of aggregate demand, and how it is achieved, in

modern DSGE analysis.

JEL codes: E10, E27, E37

Keywords: nominal rigidities, real rigidities, monetary policy.

MODERN DSGES ARE VIEWED AS the epitome of modern gen-

eral equilibrium macroeconomic analysis. Complex dynamic-programming prob-

lems are solved by a number of interacting optimizing agents, leading to equilibrium

relations immune to the Lucas critique. These relations balance general equilibrium

(GE) forces coming from the supply-side effects of exogenous technological change

and from the demand-side effects of exogenous changes in spending, together with

the effects of other shocks. These forces are amplified (or moderated) by a host of

frictions as nominal rigidities, collateral constraints, balance-sheet effects, etc. There

This is a revised version of an earlier draft entitled “The New Keynesian Model and the Small Open

Economy RBC Model: Equivalence Results for Consumption.” Wethank Dan Cao for his most valuable

input on an earlier draft of the paper; we also thank Giulia Felice and seminar and conference participants at

University of Rome “TorVergata,”University of Lausanne, Sogang University, the 20th Spring Meeting of

YoungEconomists, the 30th Annual Congress of the European Economic Association, the 69th European

Meeting of the Econometric Society, and the KEA-KAEA Joint International Conference for helpful

suggestions.

JEAN-PAUL L’HUILLIER is an Assistant Professor at Brandeis University and Einaudi Institute for Eco-

nomics and Finance (EIEF) (E-mail: jpl@brandeis.edu). DONGHOONYOO is an Associate Research Fellow

at Korea Labor Institute (E-mail: donghoonyoo@gmail.com).

Received September 8, 2017; and accepted in revised form September 6, 2018.

Journal of Money, Credit and Banking, Vol. 51, No. 6 (September 2019)

C

2018 The Ohio State University