EF9902

Macroeconomics I

Fall 2016
Ryerson University
Problem Set #4

1. [RBC Model with Increasing Returns to Scale] Consider a real business cycle
model in which the level of aggregate output affects the output of each individual
firm. There is a unit measure of identical firms which produce output using the
following technology:

yit = zt kit h1
it Yt ,

(0, 1),

(0, 1 )

(1)

where yit , kit , and hit denote output, capital, and employment for firm i [0, 1], zt
is a random productivity parameter affecting all firms symmetrically, and Yt denotes
aggregate output. Aggregate output is taken as given by each individual firm. The
productivity parameter evolves via a first-order autoregressive process:
log zt = log zt1 + t ,

(0, 1)

(2)

where is an i.i.d. shock with mean 0 and variance 2 . There is complete depreciation
of capital each period, and there are a large number (unit measure) of identical
households with logarithmic preferences over consumption of the single good and
leisure:

X
t [log ct + log(1 ht )] , (0, 1), > 0
(3)
E0
t=0

Households own identical shares in all firms and the capital stock, have one unit of
time per period, and rent labour and capital to firms in competitive factor markets
for factor prices w and r, respectively.
(i) Define a recursive competitive equilibrium for this economy and write down a
dynamic programming problem the solution to which is the equilibrium.
(ii) Derive expressions for aggregate employment, Ht , consumption, Ct , and investment/capital, Kt+1 , in equilibrium.
(iii) Derive an equation relating the (logarithm) of aggregate output at time t, log Yt ,
to log Yt1 , log zt1 and t . How does affect the variance and autocorrelation
of log Y for a given and 2 ? Explain.
(iv) Suppose now that productivity is constant, i.e. let t = 0 for all t. For this
case derive the competitive equilibrium of the economy and show that it is not
Pareto efficient.

EF9902
Macroeconomics I

Fall 2016
Ryerson University

2. [Benchmark RBC Model] Consider the standard real business cycle model. A
representative agent maximizes
E0

t [log ct + log(1 ht )] ,

(0, 1),

>0

t=0

where ct and ht denote consumption and labour hours. Output is produced using
capital, kt , and labour according to the following production technology:
yt = zt kt h1
t

(4)

where zt is the usual technology shock that evolves as follows:

log zt+1 = log zt + t+1 ,

t+1 N (0, 2 )

(5)

Capital depreciates at rate , thus

kt+1 = xt + (1 )kt

(6)

is the capital accumulation decision, where xt denotes investment in new capital. The
economy operates under the following resource constraint:
ct + x t = y t

(7)

(i) Derive the intertemporal and intratemporal Euler equations.

(ii) There are six variables, {ct , xt , kt , yt , ht , zt }, and six equations: (4),(5),(6),(7)
and the two Euler equations from part (i). Solve the system of equations
with = 0 (its unconditional mean) to find the deterministic steady state,
y, h,
z}. [Hint: it might be easier to solve for certain variables relative
{
c, x, k,
h),
then solve for employment.]
to employment (e.g., the capital-labour ratio k/
The file RBCdata.csv contains U.S. aggregate time series data from 1948 to 2012. Y
is real GDP, IF is real total private fixed investment, ID is real durable consumption,
C is the sum of real non-durable and services consumption, H is an index of total
hours worked in non-farm business sectors, P is the civilian non-institutionalized
population age 16 years and over, and LP is an index of labour productivity (output
per hour). Output, investment, and consumption data are from the U.S. Bureau of
Economic Analysis, and the labour market data come from the U.S. Department of
Labor Statistics.
2

EF9902
Macroeconomics I

Fall 2016
Ryerson University

(iii) Using the data and the matlab function for the Hodrick-Prescott filter (available
for download at http://www.mathworks.com/matlabcentral/fileexchange/3972),
separate the trend and cyclical component of the log of real GDP. In one figure,
plot the original series y = log Y and the trend. In another figure, plot the
cyclical component.
(iv) We want to measure volatility in a manner that is invariant to scale. Taking
the natural logarithm of the series first before detrending, and then computing
100 times the standard deviation of the filtered series is a standard approach
for approximating the percentage standard deviation of an HP filtered series.
Compute the following moments for the logged HP filtered series:1
Series

Std. Dev.
x

Rel. Std. Dev.

x /y

Corr. with Output

corr(x, y)

1st Order
Autocorr.

Output
Investment
Consumption
Hours
Labour Prod.
(v) Use Dynare2 to solve the stochastic version of the benchmark RBC model from
part 1 using first order log-linear approximations around the steady state of
the policy functions that solve the first-order conditions. Compute the same
moments for the simulated data, with the parameters of the model calibrated
to = 0.33, = 0.99, = 1.75, = 0.023, = 0.95, and = 0.007.3

The series for Investment should be the broadest definition of investment: the sum of total private fixed investment and consumption expenditures on durable goods. Hours should be normalized
by dividing by the working age population.
2
There is a useful guide to stochastic simulations using Dynare by Fabrice Collard:
http://www.dynare.org/documentation-and-support/tutorial/guide.pdf/at_download/file.
Also, Wouter J. den Haan has some useful slides on his website with an introduction to Dynare:
http://www.wouterdenhaan.com/notes.htm#Dynare.
3
These are the same parameters used by Hansen and Wright (1992), so you could refer to Table
3 in their paper to gauge your results.