nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2023‒01‒02
seventeen papers chosen by
Christian Zimmermann
Federal Reserve Bank of St. Louis

  1. The US Banks’ Balance Sheet Transmission Channel of Oil Price Shocks By Paolo Gelain; Marco Lorusso
  2. Asset supply and liquidity transformation in HANK By Yu-Ting Chiang; Piotr Zoch
  3. Estimación bayesiana de un modelo dinámico estocástico nuevo keynesiano de equilibrio general con reglas de política fiscal y monetaria para México By Vergara-Pérez, Sami D.; Venegas-Martínez, Francisco
  4. Should the Fiscal Authority Avoid Implementation Lag? By Masataka Eguchi; Hidekazu Niwa; Takayuki Tsuruga
  5. Why does risk matter more in recessions than in expansions? By Andreasen, Martin Møller; Caggiano, Giovanni; Castelnuovo, Efrem; Pellegrino, Giovanni
  6. Revisiting intertemporal elasticity of substitution in a sticky price model By Kilponen, Juha; Vilmunen, Jouko; Vähämaa, Oskari
  7. On robustness of average inflation targeting By Honkapohja, Seppo; McClung, Nigel
  8. Determinacy and E-stability with interest rate rules at the zero lower bound By Eo, Yunjong; McClung, Nigel
  9. Fiscal, Environmental, and Bank Regulation Policies in a Small Open Economy for the Green Transition By Patrick Gruning
  10. Public Redistributive Policies in General Equilibrium: an application to Greece By Angelos Angelopoulos; George Economides; George Liontos; Apostolis Philippopoulos; Stelios Sakkas
  11. Monetary policy rules and the effective lower bound in the Euro area By Haavio, Markus; Laine, Olli-Matti
  12. Forward guidance with unanchored expectations By Eusepi, Stefano; Gibbs, Chris; Preston, Bruce
  13. Monetary policy in a two-country model with behavioral expectations By Michał Brzoza-Brzezina; Paweł Galiński; Krzysztof Makarski
  14. Monetary Policy, Labor Force Participation, and Wage Rigidity By Hiroyuki Kubota; Ichiro Muto; Mototsugu Shintani
  15. Regional general equilibrium modelling with forward-looking agents: an application to the 2014-2020 European structural regional investments By Francesca Crucitti; Patrizio Lecca; Philippe Monfort; Simone Salotti
  16. Conditional density forecasting: a tempered importance sampling approach By Montes-Galdón, Carlos; Paredes, Joan; Wolf, Elias
  17. Climate Actions, Market Beliefs, and Monetary Policy By : Annicciarico, Barbara; : Di Dio, Fabio; : Dilusio, Francesca

  1. By: Paolo Gelain; Marco Lorusso
    Abstract: We document the existence of a quantitative relevant banks' balance-sheet transmission channel of oil price shocks by estimating a dynamic stochastic general equilibrium model with banking and oil sectors. The associated amplification mechanism implies that those shocks explain a non-negligible share of US GDP growth fluctuations, up to 17 percent, instead of 6 percent absent the banking sector. Also, they mitigated the severity of the Great Recession’s trough. GDP growth would have been 2.48 percentage points more negative in 2008Q4 without the beneficial effect of low oil prices. The estimate without the banking sector is only 1.30 percentage points.
    Keywords: oil price shocks; DSGE models; financial frictions
    JEL: E32 E44 Q35 Q43
    Date: 2022–11–15
  2. By: Yu-Ting Chiang; Piotr Zoch
    Abstract: We study how the financial sector affects fiscal and monetary policy in heterogeneous agent New Keynesian (HANK) economies. We show that, in a large class of models of financial intermediation, relevant features of the financial sector are summarized by the elasticities of a liquid asset supply function. The financial sector in these models affects aggregate responses only through its ability to perform liquidity transformation (i.e., issue liquid assets to finance illiquid capital). If liquid asset supply responds inelastically to returns on capital (low cross-price elasticities), disturbances in the liquid asset market generate large responses in aggregate demand through adjustments in capital prices. Assumptions about the financial sector are not innocuous quantitatively. In commonly used setups that imply different liquid asset supply elasticities, aggregate output responses to an unexpected deficit-financed government transfer can differ by a factor of three.
    Keywords: financial frictions; liquidity; monetary policy; fiscal policy; Heterogeneous-agent New Keynesian (HANK) model
    JEL: E2 E6 H3 H6
    Date: 2022–11–28
  3. By: Vergara-Pérez, Sami D.; Venegas-Martínez, Francisco
    Abstract: ABSTRACT: Empirical evidence for Mexico suggests that markets are not always perfect and complete since there are nominal rigidities and the public sector does not always displace the private sector. For this reason, a Dynamic Stochastic General Equilibrium (DSGE) model is used with the following assumptions: 1) monopolistic competition in the goods and labor markets, 2) non-Ricardian consumers, 3) rigid prices and wages, and 5) the role of government in the economy is driven by fiscal and monetary policy rules. We develop a system of nonlinear equilibrium equations to obtain the steady state of the economy through a linear approximation to the long-term trend. From the reduced form solution of the linear structural model, the corresponding state space system is formulated to evaluate the likelihood function associated with the Kalman filter. Once the prior distribution of the structural parameters is provided, the posterior distribution is obtained from Bayes' theorem. In this way, the Random Walk Metropolis-Hastings (RWMH) algorithm is implemented to obtain simulated samples in Markov chains from the posterior distribution. A statistical inference is made about the structural parameters. With the above, the theoretical model shows the insufficiency of aggregate demand, involuntary unemployment and the rejection of full compliance with Ricardian equivalence. We find empirical evidence in favor of price stability, the displacement effect of private spending due to the public deficit, and the non-neutrality of fiscal and monetary policies. Finally, we find evidence on the unsustainability of public debt for the Mexican economy. // RESUMEN: La evidencia empírica para México sugiere que los mercados no siempre son perfectos y completos ya que existen rigideces nominales y el sector público no siempre desplaza al sector privado. Por esta razón, se utiliza un modelo de Equilibrio General Estocástico Dinámico (EGED) con los siguientes supuestos: 1) competencia monopolística en los mercados de bienes y de trabajo, 2) consumidores no Ricardianos, 3) precios y salarios rígidos, y 5) el papel del gobierno en la economía está impulsada por las reglas de política fiscal y monetaria. Desarrollamos un sistema de ecuaciones de equilibrio no lineal para obtener el estado estacionario de la economía mediante una aproximación lineal a la tendencia de largo plazo. A partir de la solución en forma reducida del modelo estructural lineal, se formula el correspondiente sistema de espacio de estados para evaluar la función de verosimilitud asociada al filtro de Kalman. Una vez proporcionada la distribución previa de los parámetros estructurales, se obtiene la distribución posterior a partir del teorema de Bayes. De esta forma, se implementa el algoritmo Random Walk Metropolis-Hastings (RWMH) para obtener muestras simuladas en cadenas de Markov a partir de la distribución posterior. Se hace una inferencia estadística sobre los parámetros estructurales. Con lo anterior, el modelo teórico muestra la insuficiencia de la demanda agregada, el desempleo involuntario y el rechazo al pleno cumplimiento de la equivalencia Ricardiana. Encontramos evidencia empírica a favor de la estabilidad de precios, el efecto desplazamiento del gasto privado por el déficit público y la no neutralidad de las políticas fiscal y monetaria. Finalmente, encontramos evidencia sobre la insostenibilidad de la deuda pública para la economía mexicana.
    Keywords: general equilibrium, Bayesian analysis, macroeconomic models, Mexican economy // equilibrium general, análisis bayesiano, modelos macroeconómicos, economía mexicana
    JEL: E61
    Date: 2022–11–25
  4. By: Masataka Eguchi; Hidekazu Niwa; Takayuki Tsuruga
    Abstract: Implementation lags are one of policymakers' concerns about fiscal policies, as these may reduce their efficacy. Using a standard New Keynesian model with an effective lower bound on the nominal interest rate, we compare the impacts of fiscal stimulus on output across various lengths of implementation lag. We show that despite concerns among policymakers, a fiscal authority can enhance the efficacy of government purchases on output with implementation lags when the economy is caught in a liquidity trap.
    Date: 2022–11
  5. By: Andreasen, Martin Møller; Caggiano, Giovanni; Castelnuovo, Efrem; Pellegrino, Giovanni
    Abstract: This paper uses a nonlinear vector autoregression and a non-recursive identiÖcation strategy to show that an equal-sized uncertainty shock generates a larger contraction in real activity when growth is low (as in recessions) than when growth is high (as in expansions). An estimated New Keynesian model with recursive preferences and approximated to third order around its risky steady state replicates these state-dependent responses. The key mechanism behind this result is that Örms display a stronger upward nominal pricing bias in recessions than in expansions, because recessions imply higher ináation volatility and higher marginal utility of consumption than expansions.
    Keywords: New Keynesian Model,Nonlinear SVAR,Non-recursive identiÖcation,State-dependent uncertainty shock,Risky steady state
    Date: 2021
  6. By: Kilponen, Juha; Vilmunen, Jouko; Vähämaa, Oskari
    Abstract: Macroeconomic models typically assume additively separable preferences where consumption enters the utility function in a logarithmic form. This restriction implies that consumption growth is highly sensitive to movements in real interest rates, which in turn implies an unrealistically steep demand curve and intertemporal trade-off. We re-estimate the stylized New Keynesian Model with US data using King-Plosser-Rebelo (1988) preferences with and without habits and show that the equilibrium real interest rate elasticity of output is in the range of 0.05 - 0.20 in the US. Such low real interest rate elasticity is better in line with the empirical consumption Euler equation literature and implies relatively weak transmission of monetary policy to output and inflation.
    Keywords: Monetary policy,Bayesian estimation,Non-separable utility
    JEL: E32 E52 E21
    Date: 2021
  7. By: Honkapohja, Seppo; McClung, Nigel
    Abstract: This paper considers the performance of average inflation targeting (AIT) policy in a New Keynesian model with adaptive learning agents. Our analysis raises concerns regarding robustness of AIT when agents have imperfect knowledge. In particular, the target steady state can be locally unstable under learning if details about the policy are not publicly available. Near the low steady state with interest rates at the zero lower bound, AIT does not necessarily outperform a standard inflation targeting policy. Policymakers can improve outcomes under AIT by (i) targeting a discounted average of inflation, or (ii) communicating the data window for the target.
    Keywords: Adaptive Learning,Inflation Targeting,Zero Interest Rate Lower Bound
    JEL: E31 E52 E58
    Date: 2021
  8. By: Eo, Yunjong; McClung, Nigel
    Abstract: We evaluate and compare alternative monetary policy rules, namely average inflation targeting, price level targeting, and traditional inflation targeting rules, in a standard New Keynesian model that features recurring, transient zero lower bound regimes. We use determinacy and expectational stability (E-stability) of equilibrium as the criteria for stabilization policy. We find that price level targeting policy, including nominal income targeting as a special case, most effectively promotes determinacy and E-stability among the policy frameworks, whereas standard inflation targeting rules are prone to indeterminacy. Average inflation targeting can induce determinacy and E-stability effectively, provided the averaging window is sufficiently long.
    Keywords: Zero Lower Bound,Markov-Switching,Expectations,Price level targeting,Average inflation targeting,Nominal income targeting
    JEL: E31 E47 E52 E58
    Date: 2021
  9. By: Patrick Gruning (Latvijas Banka)
    Abstract: This study develops a small open economy dynamic stochastic general equilibrium model with green and brown intermediate goods, banks subject to capital requirements, and public investment. The domestic economy might face domestic or foreign carbon taxes and an emissions cap. The model is used to analyze which environmental, fiscal, and bank regulation policies are effective facilitators of the domestic economy’s green transition and the costs involved. Among the policies that can generate an exogenously imposed and fixed emissions reduction, most costly is the exogenous world brown energy price increase, followed by the emissions cap reduction, while the introduction of domestic carbon taxes does not change GDP in the long run. The reason for this stark difference is that domestic carbon taxes and emissions cap violation penalties are used to stimulate public green investment. However, only domestic carbon tax revenues are substantial as brown entrepreneurs do not violate theemissions cap in equilibrium. Bank regulation policies and other fiscal policies are not capable of generating large emissions reductions. During the green transition induced by domestic carbon taxes, the first years of the transition are characterized by a run on brown energy in anticipation of higher prices in the future.
    Keywords: small open economy, climate transition risk, energy, environmental policy, bank regulation, public investment
    JEL: E30 F41 G28 H23 H41 Q50
    Date: 2022–12–01
  10. By: Angelos Angelopoulos; George Economides; George Liontos; Apostolis Philippopoulos; Stelios Sakkas
    Abstract: We develop a general equilibrium OLG model of a small open economy to quantify the aggregate and distributional implications of a wide menu of public redistributive policies in a unified context. Inequality is driven by unequal parental conditions in financial and human capital. The model is calibrated and solved using fiscal data from Greece. Our aim is to search for public policies, targeted and non-targeted, that can reduce income inequality without damaging the macroeconomy and without worsening the public finances. Pareto-improving reforms that also reduce inequality include an increase in public education spending provided to all and an increase in the inheritance tax rate on financial wealth. At the other end, we identify reforms that may reduce inequality but make everybody worse o§. Regarding cases in between, a switch to a fully funded public pension system is good for everybody although it is the rich-born that benefit more by moving to a more efficient macroeconomy.
    Keywords: Inequality, efficiency, public policy
    Date: 2022–11
  11. By: Haavio, Markus; Laine, Olli-Matti
    Abstract: We analyze the economic performance of di§erent monetary policy strategies, or rules, in a low interest rate environment, using simulations with a DSGE model which has been estimated for the euro area. We study how often the e§ective lower bound of interest rates (ELB) is likely to bind, and how much forgone monetary policy accommodation this entails. Macroeconomic outcomes are measured by the mean levels and the volatility of output (gaps), unemployment and ináation. We present three sets of results. First, the macroeconomic costs of the ELB are likely to grow in a non-linear manner if the monetary policy space (the di§erence between the normal, or average, level of nominal interest rates and the ELB) shrinks. Second, a point ináation target appears to outperform a target range. Third, the (relative) performance of low-for-long (L4L) monetary policy rules depends on the size of the monetary policy space. The L4L rules tend to perform well, if the monetary space is small, but if the space is larger these rules, while stabilizing ináation, may lead to more volatility in the real economy than áexible ináation targeting.
    Keywords: monetary policy rules,effective lower bound,euro area
    JEL: E31 E32 E52 E58
    Date: 2021
  12. By: Eusepi, Stefano; Gibbs, Chris; Preston, Bruce
    Abstract: We study zero interest-rate policy in response to a large negative demand shock when long-run expectations can fall over time. Because falling expectations make monetary policy less effective by raising real interest rates, the optimal forward guidance policy makes large front-loaded promises to stabilize expectations. Policy is too stimulatory in the event of transitory shocks, but provides insurance against persistent shocks. The optimal policy is well-approximated by a constant calendar-based forward guidance, independent of the shock's realised persistence. The insurance property distinguishes our paper from other bounded rationality papers that solve the forward guidance puzzle and generates important quantitative differences.
    Keywords: Optimal Monetary Policy,Learning Dynamics,Expectations Stabilization,Forward Guidance
    JEL: E32 D83 D84
    Date: 2021
  13. By: Michał Brzoza-Brzezina (Narodowy Bank Polski); Paweł Galiński (Narodowy Bank Polski); Krzysztof Makarski (Narodowy Bank Polski)
    Abstract: We study the working of monetary policy in an estimated two-country model with behavioral expectations(BE). We first show that the data favors this setting compared with the standard rational expectations assumption. Then we document several findings related to monetary policy in the open-economy framework. First, under BE the Taylor principle depends on the size of the economy - determinacy regions are larger for the small country. Second, both in the small and large economies, monetary policy is less powerful when agents are behavioral. Third, the sacrifice ratio faced by the central bank increases with agents becoming more behavioral (more in the small country). Fourth, BE help to partly solve the puzzles of excess foreign currency returns (UIP puzzle) and of international monetary independence.
    Keywords: behavioral agents, monetary policy, open-economy model
    JEL: E30 E43 E52 E70
    Date: 2022
  14. By: Hiroyuki Kubota (University of California, Los Angeles (E-mail:; Ichiro Muto (Associate Director-General, Institute for Monetary and Economic Studies (currently, General Manager, Aomori Branch), Bank of Japan (E-mail:; Mototsugu Shintani (The University of Tokyo (E-mail:
    Abstract: To understand the role of monetary policy in determining the labor force participation rate, we present empirical evidence for Japan and the US. The data suggests that labor force participation declines in Japan but increases in the US in response to a monetary tightening. To inspect the mechanism, we develop and estimate a New Keynesian model of endogenous labor force participation decisions incorporating wage rigidity. We find that the opposite response of labor force participation can be attributed to a difference in the degree of wage rigidity. Counterfactual analysis based on the estimated models shows that the large-scale monetary easing in recent years helped boost the labor force participation rate in Japan, while its effect was almost neutral in the US.
    Keywords: Labor force participation, Monetary policy, Unemployment, Wage rigidity
    JEL: E24 E32 E52 E58
    Date: 2022–11
  15. By: Francesca Crucitti (European Commission - JRC); Patrizio Lecca (Comillas Pontifical University); Philippe Monfort (European Commission - DG REGIO); Simone Salotti (European Commission - JRC)
    Abstract: We investigate the effects of the 2014-20 European structural funds with a general equilibrium model calibrated on the NUTS 1 regions of the EU. We assume forward-looking agents to account for expectations and long-lasting effects of the policy. The almost €260 billion of investments lead the European GDP to be 0.3% higher in 2022 than it would be in the absence of the policy. Interestingly, this effect is lower than what a model with myopic agents would suggest. The regional distribution of the differences in the GDP impacts between the two settings indicates that the largest deviations are recorded for the net recipient regions, with interesting implications regarding the policy credibility, the nature of the interventions and their duration.
    Keywords: General equilibrium modelling, forward-looking behaviour, regional economics, cohesion policy.
    JEL: C68 D58 R13
    Date: 2022–10
  16. By: Montes-Galdón, Carlos; Paredes, Joan; Wolf, Elias
    Abstract: This paper proposes a new and robust methodology to obtain conditional density forecasts, based on information not contained in an initial econometric model. The methodology allows to condition on expected marginal densities for a selection of variables in the model, rather than just on future paths as it is usually done in the conditional forecasting literature. The proposed algorithm, which is based on tempered importance sampling, adapts the model-based density forecasts to target distributions the researcher has access to. As an example, this paper shows how to implement the algorithm by conditioning the forecasting densities of a BVAR and a DSGE model on information about the marginal densities of future oil prices. The results show that increased asymmetric upside risks to oil prices result in upside risks to inflation as well as higher core-inflation over the considered forecasting horizon. Finally, a real-time forecasting exercise yields that introducing market-based information on the oil price improves inflation and GDP forecasts during crises times such as the COVID pandemic. JEL Classification: C11, C53, E31, E37
    Keywords: Bayesian analysis, forecasting, importance sampling, inflation-at-risk
    Date: 2022–12
  17. By: : Annicciarico, Barbara (Universita degli Studi di Roma Tor Vergata); : Di Dio, Fabio (European Commission); : Dilusio, Francesca (Bank of England)
    Abstract: This paper studies the role of expectations and monetary policy on the economy’s response to climate actions. We show that in a stochastic environment and without the standard assumption of perfect rationality of agents, there is more uncertainty regarding the path and the economic impact of a climate policy, with a potential threat to the ability of central banks to maintain price stability. Market beliefs and behavioural agents increase the trade-offs inherent to the chosen mitigation tool, with a carbon tax entailing more emissions uncertainty than in a rational expectations model and a cap-and-trade scheme implying a more pronounced pressure on allowances prices and inflation. The impact on price stability is worsened by delays in the implementation of stringent climate policies, by the lack of confidence in the ability of central banks to keep inflation under control, and by the adoption of monetary rules tied to expectations rather than current macroeconomic conditions. Central banks can implement successful stabilization policies that reduce the uncertainty surrounding the impact of climate actions and support the greening process while staying within their mandate.
    Keywords: Monetary policy; climate policy; expectations; inflation; market sentiments; business cycle
    JEL: D58 Q50 E32 E71
    Date: 2022–09

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