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2020 | OriginalPaper | Chapter

7. The Advanced Model

Author : Daniel Lukui Jia

Published in: Dynamic Macroeconomic Models in Emerging Market Economies

Publisher: Springer Singapore

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Abstract

Based on the basic model, the advanced model is proposed in this chapter. It is advanced in that it further explores the heterogeneities within urban and rural household groups: urban households are divided into lenders and borrowers. Under such an assumption, urban lenders own the capital and lend to other urban households, the urban household borrowers. Both household borrowers and lenders possess housing property, which is explicitly introduced into the utility functions of these households. In contrast to the urban households, the rural ones are assumed to own no housing property, or no real estate with material market value. Such an assumption reconciles the structure of model economy with the facts of situations in emerging market economies. Similar to the previous chapter, the model framework is included in the first section, followed by a summary of theoretical hypotheses.

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previous chapter The Basic Model

next chapter The Full Model

The word ‘migrant’ reflects the fact that these agents are from rural parts of the economy but live and work in the urban areas. According to China’s National Bureau of Statistics, the number of migrant workers rose to 280 million in 2019.

Compared to goods production, the production of real estate assets, or put it in another way, building construction, is of a lower level of technology and skill, especially concerning the property development in emerging market economies. Therefore, the majority of the working force in the building construction industry are workers from rural areas.

For more details on habit formation in household consumption function, one may refer to Bouakez et al. [1].

The importance of real estate in overall household wealth has been discussed at length in the literature review and further demonstrated in the data analysis chapter.

The details of CES aggregation and Dixit–Stiglitz aggregator can be found in Dixit and Stiglitz’s contribution [8].

\(\epsilon _{p}>1\) and the elasticity of substitution among different final goods increase as \(\epsilon _{p}\) becomes larger. In the extreme case \(\epsilon _{p}\rightarrow \infty \), which means perfect substitution.

The most popular way to set parameter \(\theta _{\pi }\) is to assume that \(\theta _{\pi }=0.75\), as this will assure that the average life of final goods price is 1 year.

According to Davis and Heathcote [9], who quantitatively analyse the quarterly data in the United States from 1952:1 to 2007:4, housing price fluctuations are mainly determined by the change of the land price.

For details, see Davis and Heathcote [9].

The detailed explanation of Walras’ Law can be found in the work of Tsiang [11].

Although some may argue that, even in emerging market economies such as Brazil, India and China, workers are protected by law with maximum working hours up to 8. But the actual situation is far more complicated. This kind of regulation is not completely executed in emerging market economies. What is more, people in the lower level of social classes in these countries are willing to work additional hours to gain more income. As shown in the empirics of Messenger et al. [12], Harriss [13], Spector et al. [14], Hu et al. [15], Wong et al. [16], and many others, empirical evidence indicates that a large portion of workers, especially in construction and labour-intensive manufacture industries, in emerging market economies like Brazil, India and China, tend to work 10–14 hours per day; the evidence strongly supports this assumption.

In fact, it is a natural result of the assumption implied in this advanced model, in which mortgage collateralized by property is fully settled without default (the Walras’ Law). We do not introduce the possibility of default in property loans because of three reasons. Firstly, we want to focus on the dynamics between interest rate, housing market price movements and business cycles. Secondly, household loans collateralized by real estate are of lower possibility of default than that of entrepreneur loans (in the full model, the possibility of default of entrepreneur loans and thus bankruptcy rate will be considered). Thirdly, laws and regulations of bankruptcy of individuals are not fully installed in emerging market economies, making it difficult to consider such cases. In conclusion, this simplification does not change the major mechanism we wish to analyse.

Unfortunately, there is hardly a paper-pencil solution for this group of equations. MATLAB helps us to solve for these values using numerical methods. The details of solving steady-state values for the advanced and the full models are demonstrated in the following parts of this book.

More specifically, this group of household includes people who live and work in urban areas but with insufficient ability to buy property. They either rent accommodation or live in properties with negligible market value. These people may not come from rural areas. In our model, we still include them as rural migrant workers since they share common economic features with rural migrant workers.

More generally, the definition of ‘urban’ and ‘rural’ in this model are not necessarily restricted in their geographic conception. They can be conceived or explained as more developed and less developed areas as well. Thus, this model can be used in the analysis of economies with material gap between geographic areas and/or social classes, each of which represents a non-negligible part of the whole population.

Even some of them may have real estate assets, their property assets are either unmarketable as the situation in China, where most of real estate assets in rural area can not be traded, or the value of their property assets is negligible, as the properties in slums.

Bouakez, H., Cardia, E., & Ruge-Murcia, F. (2005). Habit formation and the persistence of monetary shocks. Journal of Monetary Economics, 52(6), 1073–1088.CrossRef

Bernanke, B., Gertler, M., & Gilchrist, S. (1999). The financial accelerator in a quantitative business cycle framework. Handbook of Macroeconomics, 1, 1341–1393.CrossRef

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Dixit, A. K., & Stiglitz, J. E. (1977). Monopolistic competition and optimum product diversity. The American Economic Review, 67(3), 297–308.

Davis, M. A., & Heathcote, J. (2007). The price and quantity of residential land in the United States. Journal of Monetary Economics, 54(8), 2595–2620.CrossRef

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Liu, Z., Wang, P., & Zha, T. (2013). Land-price dynamics and macroeconomic fluctuations. Econometrica, 81(3), 1147–1184.CrossRef

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Tsiang, S. C. (1966). Walras’ Law, Say’s Law and liquidity preference in general equilibrium analysis. International Economic Review, 7(3), 329–345.CrossRef

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Messenger, J., Lee, S., & McCann, D. (2007). Working time around the world: Trends in working hours, laws and policies in a global comparative perspective. Indian Journal of Physiology & Pharmacology, 58(2), 182–183.

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Title: The Advanced Model
Author: Daniel Lukui Jia
Publisher: Springer Singapore
Book: Dynamic Macroeconomic Models in Emerging Market Economies
Print ISBN: 978-981-15-4587-0

Electronic ISBN: 978-981-15-4588-7

Copyright Year: 2020
DOI: https://doi.org/10.1007/978-981-15-4588-7_7