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on Dynamic General Equilibrium |
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Issue of 2024‒05‒13
thirteen papers chosen by |
| By: | Harrison, Richard (Bank of England) |
| Abstract: | This paper studies optimal monetary policy in a New Keynesian model with portfolio frictions that create a role for the central bank balance sheet as a policy instrument. Central bank purchases of long‑term government debt (‘quantitative easing’) reduce average portfolio returns, thereby increasing aggregate demand and inflation. Optimal time‑consistent policy prescribes large and rapid asset purchases when the policy rate hits the zero bound. Optimal balance sheet reduction (‘quantitative tightening’) is more gradual. A central bank that pursues a flexible inflation target can achieve similar welfare to optimal policy if quantitative tightening is calibrated appropriately. |
| Keywords: | Quantitative easing; quantitative tightening; optimal monetary policy; zero lower bound |
| JEL: | E52 E58 |
| Date: | 2024–03–08 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1063&r=dge |
| By: | Batten, Sandra (Bank of England); Millard, Stephen (National Institute of Economic and Social Research, Durham University Business School, University of Portsmouth and Centre for Macroeconomics) |
| Abstract: | We build an open economy Dynamic Stochastic General Equilibrium model with energy and use it to simulate the impact of different climate policies – specifically the introduction of a carbon tax and bans on petrol or gas usage by households – on macroeconomic variables. We show how the introduction of a carbon tax leads to falls in both households’ consumption of energy and firms’ use of energy in production, while also having the effect of shifting the production of electricity from fossil fuels to renewable sources. The effects of a ban on household consumption of petrol or gas depend crucially on the elasticity of substitution between different energy sources in consumption. For very low elasticities of substitution, a ban on petrol or gas usage also led households to cut down on their use of electricity, whereas for larger elasticities of substitution, households switched into electricity. Regardless of the elasticity of substitution, aggregate consumption fell on impact in response to the bans before rising over time. GDP and the gross output of non‑energy fall in response to both a carbon tax and a ban on petrol or gas consumption by households. Finally, both policies result in a temporary increase in inflation and a tightening in monetary policy. |
| Keywords: | Climate change; dynamic stochastic general equilibrium; carbon tax; climate policy; energy; energy policy; renewable energy; macroeconomics; UK economy |
| JEL: | E32 Q28 Q38 Q43 Q48 Q58 |
| Date: | 2024–03–08 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1064&r=dge |
| By: | Ida, Daisuke |
| Abstract: | This study explores how the real money balance effect (RMBE) affects the neo-Fisherian effect (NFE) in a standard new Keynesian model. First, we find that the presence of the RMBE can partly explain the occurrence of the NFE, and that increasing the nonseparability parameter magnifies the positive response of the nominal interest rate to a persistent inflation target shock. Second, we show that the degree of nominal price stickiness is important in explaining how the RMBE amplifies the NFE. In sum, this study addresses how the presence of the RMBE facilitates generating the NFE. |
| Keywords: | Neo-Fisherian effect; New Keynesian model; Real money balances; Interest rates; Inflation |
| JEL: | E52 E58 |
| Date: | 2024–03–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:120575&r=dge |
| By: | Yunmin Chen (National Central University, Taiwan); Jang-Ting Guo (Department of Economics, University of California Riverside) |
| Abstract: | In the context of a dynamic (three-period) general equilibrium model, this paper examines the optimal tax rates on capital savings and labor income under quasi-hyperbolic discounting and idiosyncratic productivity shocks. In the absence of skill-type uncertainty, we analytically show that the marginal capital tax wedges on agents' first-period savings are negative for correcting inherent preference internalities, and that these tax rates will be higher when productivity disturbances are incorporated. In the stochastic two-type setting with exogenously-given factor input prices, our calibrated numerical experiments find that the marginal capital wedges for both types on their period-1 savings are positive, indicating the government's motive to relax individuals' incentive-compatibility constraints. We also quantitatively find that the optimal tax rates for both types on their first- and second-period capital savings, as well as the economy's social welfare, are ceteris paribus decreasing in the degree of quasi-hyperbolic discounting because of a stronger need to rectify negative utility internalities. |
| Keywords: | Optimal Dynamic Income Taxation; Quasi-Hyperbolic Discounting; Idiosyncratic Productivity Shocks. |
| JEL: | D91 H21 H24 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:ucr:wpaper:202403&r=dge |
| By: | Mariano Kulish; James Morley; Nadine Yamout; Francesco Zanetti |
| Abstract: | We examine the relevance of Dutch Disease through the lens of an open-economy multisector model that features unemployment due to labor market frictions. Bayesian estimates for the model quantify the effects of both business cycle shocks and structural changes on the unemployment rate. Applying our model to the Australian economy, we find that the persistent rise in commodity prices in the 2000s led to an appreciation of the exchange rate and fall in net exports, resulting in upward pressure on unemployment due to sectoral shifts. However, this Dutch Disease effect is estimated to be quantitatively small and offset by an ongoing secular decline in the unemployment rate related to decreasing relative disutility of working in the non-tradable sector versus the tradable sector. The changes in labor supply preferences, along with shifts in household preferences towards non-tradable consumption that are akin to a process of structural transformation, makes the tradable sector more sensitive to commodity price shocks but a smaller fraction of the overall economy. We conclude that changes in commodity prices are not as relevant as other shocks or structural changes in accounting for unemployment even in a commodity-rich economy like Australia. |
| Date: | 2024–04–24 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:1045&r=dge |
| By: | Bandera, Nicolò (Bank of England); Stevens, Jacob (University of St Andrews) |
| Abstract: | We study the macroeconomic implications of non-bank financial institutions (NBFIs) in the context of the 2022 UK gilt crisis and estimate the monetary policy spillovers of financial stability interventions. We make three contributions. First, we develop the first DSGE model featuring liability driven investment (LDI) and pension funds. This novel framework in which LDI activity amplifies the movements in gilt prices allows us to replicate the UK gilt crisis, demonstrating a crucial mechanism through which NBFIs can amplify financial and economic distress. Second, we quantitatively estimate the monetary policy spillovers of the Bank of England financial stability asset purchases. We find that the asset purchases were successful in offsetting LDI-driven gilt market dysfunction. The temporary, targeted nature of these purchases was crucial in avoiding monetary spillovers. Third, we model two counterfactual instruments – an NBFI repo tool and a macroprudential liquidity buffer – and compare their effectiveness as well as monetary spillovers. Our results show that the central bank can successfully address NBFI-driven market stress without loosening monetary policy, avoiding potential tensions between price and financial stability |
| Keywords: | Monetary policy; financial stability; asset purchases; liquidity crisis; liability-driven investors; gilt; DSGE model |
| JEL: | C68 E44 E52 E58 G01 G23 |
| Date: | 2024–04–05 |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:1070&r=dge |
| By: | Mathias Krogh (Aarhus University); Giovanni Pellegrino (University of Padova and Aarhus University) |
| Abstract: | We extend a state-of-the-art DSGE model to include short- and long-term uncertainty shocks that differ in terms of persistence. Considering the two shocks is essential for capturing the imperfect empirical relationship between short- and long-term financial uncertainty as proxied by the VIX. Leveraging the model’s implications about the VIX term structure, we suggest a theory-informed, nonrecursive identification strategy to separately identify the macroeconomic effects of the two shocks in a structural VAR. In line with the DSGE model, long-term uncertainty shocks have stronger and more persistent real effects than short-term shocks. Moreover, they explain a substantial fraction of the forecast error variance in unemployment and the policy rate at horizons greater than two years. In a supplementary analysis of uncertainty news shocks, we show that news about higher uncertainty in the future is recessionary. |
| Keywords: | uncertainty shocks, medium-scale DSGE model, structural VAR, nonrecursive identification, VIX term structure. |
| URL: | http://d.repec.org/n?u=RePEc:pad:wpaper:0310&r=dge |
| By: | Boaz Abramson (Columbia GSB); Job Boerma (University of Wisconsin-Madison); Aleh Tsyvinski (Yale University) |
| Abstract: | We develop an economic theory of mental health. The theory is grounded in classic and modern psychiatric literature, is disciplined with micro data, and is formalized in a life-cycle heterogeneous agent framework. In our model, individuals experiencing mental illness have pessimistic expectations and lose time due to rumination. As a result, they work less, consume less, invest less in risky assets, and forego treatment which in turn reinforces mental illness. We quantify the societal burden of mental illness and evaluate the efficacy of prominent policy proposals. We show that expanding the availability of treatment services and improving treatment of mental illness in late adolescence substantially improve mental health and welfare. |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:2387&r=dge |
| By: | Rupal Kamdar (Indiana University); Walker Ray (London School of Economics and CEPR) |
| Abstract: | Using survey data, we show that consumers’ economic beliefs are driven by one component, which observationally behaves like “sentiment.” Surprisingly, “optimistic” consumers expecting an expansion also predict disinflation, contrasting with professional forecasts. We explain these facts in a New Keynesian model where rationally inattentive consumers face fundamental uncertainty regarding aggregate demand and supply shocks. Optimal information-gathering economizes on information costs but compresses the dimensionality of consumer beliefs. Moreover, because supply-driven recessions are more costly for typical households relying on labor income, more attention is optimally devoted to supply shocks. Inflation is hence perceived as countercyclical; the apparent “sentiment” factor structure of beliefs reflects consumers’ optimal focus on aggregate supply shocks. Business cycle dynamics depend crucially on the evolution of aggregate belief misperceptions. Finally, policies which aim to stimulate the economy by raising inflation expectations can have counterproductive consequences. |
| Keywords: | expectations, rational inattention, surveys, business cycles |
| Date: | 2024–03 |
| URL: | http://d.repec.org/n?u=RePEc:inu:caeprp:2024003&r=dge |
| By: | Iñaki Aldasoro; Sebastian Doerr; Leonardo Gambacorta; Daniel Rees |
| Abstract: | This paper studies the effects of artificial intelligence (AI) on sectoral and aggregate employment, output and inflation in both the short and long run. We construct an index of industry exposure to AI to calibrate a macroeconomic multi-sector model. Building on studies that find significant increases in workers' output from AI, we model AI as a permanent increase in productivity that differs by sector. We find that AI significantly raises output, consumption and investment in the short and long run. The inflation response depends crucially on households' and firms' anticipation of the impact of AI. If they do not anticipate higher future productivity, AI adoption is initially disinflationary. Over time, general equilibrium forces lead to moderate inflation through demand effects. In contrast, when households and firms anticipate higher future productivity, inflation rises immediately. Inspecting individual sectors and performing counterfactual exercises we find that a sector's initial exposure to AI has little correlation with its long-term increase in output. However, output grows by twice as much for the same increase in aggregate productivity when AI affects sectors producing consumption rather than investment goods, thanks to second round effects through sectoral linkages. We discuss how public policy should foster AI adoption and implications for central banks. |
| Keywords: | artificial intelligence, generative AI, inflation, output, productivity, monetary policy |
| JEL: | E31 J24 O33 O40 |
| Date: | 2024–04 |
| URL: | http://d.repec.org/n?u=RePEc:bis:biswps:1179&r=dge |
| By: | Christopher J. Erceg; Marcin Kolasa; Jesper Lindé; Mr. Andrea Pescatori |
| Abstract: | Many countries have used energy subsidies to cushion the effects of high energy prices on households and firms. After documenting the transmission of oil supply shocks empirically in the United States and the Euro Area, we use a New Keynesian modeling framework to study the conditions under which these policies can curb inflation. We first consider a closed economy model to show that a consumer subsidy may be counterproductive, especially as an inflation-fighting tool, when applied globally or in a segmented market, at least under empirically plausible conditions about wage-setting. We find more scope for energy subsidies to reduce core inflation and stimulate demand if introduced by a small group of countries which collectively do not have much influence on global energy prices. However, the conditions under which consumer energy subsidies reduce inflation are still quite restrictive, and this type of policy may well be counterproductive if the resulting increase in external debt is high enough to trigger sizeable exchange rate depreciation. Such effects are more likely in emerging markets with shallow foreign exchange markets. If the primary goal of using fiscal measures in response to spikes in energy prices is to shield vulnerable households, then targeted transfers are much more efficient as they achieve their goals at lower fiscal cost and transmit less to core inflation. |
| Keywords: | Energy Prices; Energy Subsidies; Monetary Policy; International Spillovers |
| Date: | 2024–04–05 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:2024/081&r=dge |
| By: | Shangshang Li |
| Abstract: | This paper evaluates gains from international monetary policy cooperation between the financial centre and periphery countries in a two-country open economy model consistent with global financial cycles. Compared to the non-cooperative Nash equilibrium, the optimal cooperative equilibrium robustly fails to benefit both countries simultaneously. The financial periphery is more likely to gain from cooperation if it raises less foreign currency debt or is relatively small. These results also hold when considering the transitional gains and losses of moving from non-cooperation to cooperation. The uneven distribution of gains from cooperation persists when both countries adopt implementable policy rules with and without cooperation. Nevertheless, both countries gain when transitioning from the Nash to the cooperative implementable rules. Regardless of the financial centre's policy, rules responding to the exchange rate dominate over purely inward-looking rules for the financial periphery. |
| Keywords: | policy cooperation, global financial cycle, currency mismatch |
| JEL: | E44 E52 E58 E61 F34 F42 |
| URL: | http://d.repec.org/n?u=RePEc:liv:livedp:202405&r=dge |
| By: | Shangshang Li |
| Abstract: | This paper studies the effect of political costs on implementing structural reforms in a macroeconomic political economy model with heterogeneous agents. I consider product market deregulation as a reform measure. In the model, deregulation creates potential winners and losers, and the potential losers endogenously decide to participate in political actions to impose political costs for the government. This political cost forces the government to implement an inefficiently high regulation level. A higher proportion of liquidity-constrained workers and a higher use of fixed-term labour contracts raise market regulation levels. In addition, high initial regulation levels are associated with a larger decrease in regulation levels in subsequent periods, consistent with the empirical literature. Compensation schemes, labour market reform, and strong government leadership in negotiation also help deregulation. Finally, I use the model to discuss why product markets are more deregulated in some European countries than in others. |
| Keywords: | structural reforms, product market deregulation, political economy, heterogeneous-agent model |
| JEL: | D72 E02 E60 P11 |
| URL: | http://d.repec.org/n?u=RePEc:liv:livedp:202404&r=dge |