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on Dynamic General Equilibrium |
| By: | Frederik Kurcz |
| Abstract: | In macroeconomic models featuring borrowing-constrained agents, the effects of monetary policy depend on the fiscal reaction to interest rate changes. This paper presents new evidence on the dynamic causal effects of U.S. monetary policy shocks on fiscal instruments and estimates a Heterogeneous Agent New Keynesian model with fiscal feedback rules to match the empirical results. I find that U.S. fiscal policy responds to monetaryinduced output contractions with debt-financed, countercyclical tax and transfer policies, amid a gradual decline in spending to accommodate the debt increase. The model implies that monetary policy unopposed by a business cycle stabilization motive of fiscal policy would be roughly one third more contractionary. |
| Keywords: | Macroeconomic policy, HANK, monetary fiscal interaction, Impulse Response Matching |
| JEL: | E21 E52 E60 E63 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:diw:diwwpp:dp2109 |
| By: | Shabalina, Ekaterina; Tzaawa-Krenzler, Mary |
| Abstract: | We study how heterogeneous attention to inflation across households affects the transmission of monetary policy. Using household-level surveys for the US and Australia, we first show that households' attention to inflation varies across income levels. Specifically, we find that high-income households pay more attention to inflation than other income groups. To quantify the effects for the aggregate economy, we build a Heterogeneous Agent New Keynesian model with an endogenous attention choice where the level of attention to inflation varies along the income distribution. Compared to fully rational inflation expectations, we find that the economy faces a less severe recession after a monetary policy tightening when households' expectations are stable. This result is driven by the misperceived fall in future real labor income of low-income households that incentivizes an increase in their labor supply. At the same time, in response to the tightening, low-earners experience an even larger decrease in their welfare under inattention compared to the rational expectations case. |
| Keywords: | Inattention, HANK, Monetary Policy, Inflation Expectations |
| JEL: | D84 D91 E21 E71 E52 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:imfswp:315192 |
| By: | Goenka, Aditya; Liu, Lin; Nguyen, Manh-Hung; Pang, Haokun |
| Abstract: | We model the impact of rising temperatures on labor productivity, labor market dynamics, and income inequality. Using a heterogeneous agent continuous-time (HACT) model with directed search, we analyze how temperature-induced productivity fluctuations influence the labor market, income and wealth in-equality, and wealth accumulation. The model features workers differentiated by wealth, productivity, and location, where temperature affects transitions be-tween high and low productivity states. Firms post fixed-wage contracts, and workers direct their job search across segmented labor markets. We calibrate the model using Vietnamese Labor Force data (2009-2018) matched with me-teorological records, capturing regional temperature variations. With increased temperatures, in low wage markets the ratio of vacancies to unemployed workers searching in those market falls, as labor productivity declines and falling wealth leads workers to direct their search to these markets when vacancies are also falling. The wage distribution shifts to the left, and average incomes and wealth fall. Climate-induced productivity shocks amplify income and wealth disparities as wealthier individuals are able to self-insure better against the income risk. The results underscore the role of climate change in shaping labor market inequality and provide insights into policy interventions that may mitigate its adverse effects. |
| Keywords: | Climate change; HACT model; Directed searc; Income inequality |
| JEL: | Q54 J64 J23 J31 E24 |
| Date: | 2025–03 |
| URL: | https://d.repec.org/n?u=RePEc:tse:wpaper:130422 |
| By: | Zainab Iftikhar (University of Bonn & CEPR); Anna Zaharieva (Bielefeld University) |
| Abstract: | In this study we evaluate the effects of low-skilled immigration on small businesses, wages and employment in Germany. We develop a search and matching model with heterogeneous workers, cross-skill matching, and endogenous entry into entrepreneurship. The model is calibrated using German Socio-Economic Panel (SOEP) data. Quantitative analysis shows that low-skilled immigration benefits high-skilled workers while negatively affecting the welfare of low-skilled workers. It leads to the endogenous expansion of immigrant entrepreneurial activities, generating positive spillovers for all demographic groups except native entrepreneurs. Overall, there is a marginal loss to the economy in terms of per worker welfare. This loss is mitigated with increased skilled migration from India. Policies restricting immigrant entrepreneurship relax competition for native small businesses but reduce welfare for all other worker groups. Ethnic segregation of small businesses benefits low-skill native entrepreneurs. |
| Keywords: | Entrepreneurship, small business, self-employment, search frictions, immigration |
| JEL: | J23 J31 J61 J64 L26 |
| Date: | 2025–03 |
| URL: | https://d.repec.org/n?u=RePEc:ajk:ajkdps:358 |
| By: | Matteo Iacoviello (Federal Reserve Board of Governors and CEPR); Ricardo Nunes (University of Surrey); Andrea Prestipino (Federal Reserve Board of Governors) |
| Abstract: | We study optimal credit market policy in a stochastic, quantitative, general equilibrium, infinite-horizon economy with collateral constraints tied to housing prices. Collateral constraints yield a competitive equilibrium that is Pareto inefficient. Taxing housing in good states and subsidizing it in recessions leads to a Pareto-improving allocation for borrowers and savers. Quantitatively, the welfare gains afforded by the optimal tax are significant. The optimal tax reduces the covariance of collateral prices with consumption, and, by doing so, it increases asset prices on average, thus providing welfare gains both in steady state and around it. We also show that the welfare gains stem from mopping up after the crash rather than a pure ex-ante macroprudential aspect, aligning with prior research that emphasizes the importance of ex-post measures compared to preventative policies alone. |
| JEL: | E32 E44 G18 H23 R21 |
| Date: | 2025–03 |
| URL: | https://d.repec.org/n?u=RePEc:sur:surrec:0225 |
| By: | Dirk Krueger (University of Pennsylvania, CEPR and NBER); Chunzan Wu (Peking University) |
| Abstract: | Household consumption and welfare are more strongly associated with lifetime income, but most countries base income taxes on current income and use progressive taxes to reduce inequality and provide social insurance. Is lifetime income a better tax base for a government seeking to provide social insurance and redistribution? To answer this question, we build a quantitative life-cycle model of heterogeneous households with endogenous labor supply and idiosyncratic wage risks, and calibrate it to the U.S. economy. We document that switching to a lifetime income tax leads to a more efficient distribution of hours worked over time and across states of the world. This benefit rises with tax progressivity under a lifetime income tax, whereas the opposite is true under an annual income tax. Consequently, the optimal lifetime income tax is more progressive and achieves larger ex-ante welfare for a cohort of households than the optimal annual income tax. |
| Keywords: | Lifetime Income Tax, Progressive Taxation, Redistribution, Social Insurance. |
| JEL: | E60 H20 |
| Date: | 2025–04–02 |
| URL: | https://d.repec.org/n?u=RePEc:pen:papers:25-011 |
| By: | Marcin Kolasa (SGH Warsaw School of Economics, IMF International Monetary Fund); Małgorzata Walerych (Institute of Economics, Polish Academy of Sciences); Grzegorz Wesołowski (Faculty of Economic Sciences, University of Warsaw) |
| Abstract: | This paper examines the effects of asset purchase programs (APPs) that were implemented in a number of countries during the COVID-19 pandemic in concert with large fiscal stimulus packages. We identify APP shocks for 14 advanced and emerging market economies using high-frequency identification techniques. We next estimate panel local projections, finding that APPs tend to stimulate output, but decrease prices. By using a Kitagawa-Blinder-Oaxaca decomposition, we demonstrate that these responses significantly depend on the magnitude of the simultaneously applied fiscal stimulus. Remarkably, higher government purchases during that period crowded in private consumption and had a large effect on inflation. We show that these empirical findings, some of which are inconsistent with a standard New Keynesian framework, can be rationalized in a simple general equilibrium model with segmented asset markets and fiscal dominance. |
| Keywords: | asset purchases, monetary-fiscal interactions, fiscal dominance, high-frequency identification, local projections, general equilibrium models |
| JEL: | E44 E52 F41 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:war:wpaper:2025-08 |
| By: | Jonas D. M. Fisher; Bart Hobijn; Alessandro Villa |
| Abstract: | We provide a brief primer on how the core of usable macroeconomic theory for monetary policymakers has evolved over the past 50 years. Today’s policy discussions center on the New Keynesian (NK) synthesis, which builds on the Neoclassical growth model and the AS-AD framework. It incorporates nominal and real rigidities, financial and labor market frictions, the importance of expectations, and inspired terms used by policymakers such as “anchored inflation expectations” and “forward guidance.” While essential for communication during the Great Recession and Covid-19 pandemic, these events also revealed the NK model’s limitations. Newer models incorporating heterogeneous agents potentially offer richer policy insights but add complexity and the challenge of distilling their main policy implications going forward. |
| Keywords: | economic history; Monetary policy |
| JEL: | B22 E50 |
| Date: | 2025–02–27 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedhwp:99676 |
| By: | Christian Bayer (University of Bonn, CEPR, CESifo & IZA); Alexander Kriwoluzky (Freie Universität Berlin & DIW Berlin); Gernot J. Müller (University of Tübingen, CEPR & CESifo); Fabian Seyrich (Frankfurt School of Finance & Management & DIW Berlin) |
| Abstract: | The distributional and disruptive effects of energy supply shocks are potentially large. We study the effectiveness of alternative fiscal responses in a two-country HANK model calibrated to the euro area. Subsidies can stabilize the domestic economy, but they are fiscally costly and generate negative spillovers to the rest of the monetary union: What the subsidizing country gains, other countries lose. Transfers based on historical gas consumption in the form of a Slutsky compensation are less effective domestically than subsidies, but do not harm economic activity abroad. Moreover, transfers increase domestic welfare, while subsidies decrease it. |
| Keywords: | Energy Crisis, Subsidies, Transfers, HANK2, Monetary Union, International Spillovers, Heterogeneity, Inequality, Households |
| JEL: | D31 E64 F45 Q41 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:ajk:ajkdps:361 |
| By: | Pablo A. Cuba-Borda; Albert Queraltó; Ricardo M. Reyes-Heroles; Mikaël Scaramucci |
| Abstract: | We explore how shocks to trade costs affect inflation dynamics in the global economy. We exploit bilateral trade flows of final and intermediate goods together with the structure of static trade models that deliver gravity equations to identify exogenous changes in trade costs between countries. We then use a local projections approach to assess the effects of trade cost shocks on consumer price (CPI) inflation. Higher trade costs of final goods lead to large but short-lived increases in inflation, while increases in trade costs of intermediate goods generate small but persistent increases in inflation. We develop a multi-country New Keynesian model featuring trade in final and intermediate goods and show that it can replicate the inflation responses we identify in the data. We estimate the model using historical data and use it to explore the drivers of U.S. inflation in the aftermath of the COVID-19 pandemic. We find that trade costs account for one percentage point of additional inflation in 2022 and the bulk of inflationary pressures in 2023. |
| Keywords: | inflation; international trade; trade costs; New Keynesian model; post-pandemic inflation; monetary policy; gravity equations |
| JEL: | E10 E30 F10 F40 F60 |
| Date: | 2025–03–04 |
| URL: | https://d.repec.org/n?u=RePEc:fip:feddwp:99656 |
| By: | Hassan Afrouzi (Columbia University); Andrés Esteban Blanco (FRB Atlanta); Andrés Drenik (UT Austin); Erik Hust (Chicago Booth) |
| Abstract: | In this paper, we develop a model that combines elements of modern macro labor theories with nominal wage rigidities to study the consequences of unexpected inflation on the labor market. The slow and costly adjustment of real wages within a match after a burst of inflation incentivizes workers to engage in job-to-job transitions. Such dynamics after a surge in inflation lead to a rise in aggregate vacancies relative to unemployment, associating a seemingly tight labor market with lower average real wages. Calibrating with pre-2020 data, we show the model can simultaneously match the trends in worker flows and wage changes during the 2021-2024 period. Using historical data, we further show that prior periods of high inflation were also associated with an increase in vacancies and an upward shift in the Beveridge curve. Finally, we show that other “hot labor market” theories that can cause an increase in the aggregate vacancy-to-unemployment rate have implications that are inconsistent with the worker flows and wage dynamics observed during the recent inflationary period. Collectively, our calibrated model implies that the recent inflation in the United States, all else equal, reduced the welfare of workers through real wage declines and other costly actions, providing a model-driven reason why workers report they dislike inflation. |
| Keywords: | Inflation, Vacancies, Job-to-Job Flows, Beveridge Curve, Wage Growth |
| JEL: | E24 E31 J31 J63 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:aoz:wpaper:358 |
| By: | Lukas Altermatt; Hugo van Buggenum; Lukas Voellmy |
| Abstract: | We introduce banks that issue liquid deposits backed by illiquid bonds and capital into an otherwise standard cash-in-advance economy. Liquidity transformation can lead to multiple steady-state equilibria with different interest rates and real outcomes. Whenever multiple equilibria exist, one of them is a 'liquidity trap', in which nominal bond rates equal zero and banks are indifferent between holding bonds or reserves. Whether economic activity is higher in a liquidity trap or in a (coexisting) equilibrium with positive interest rates is ambiguous, but the liquidity trap equilibrium is more likely to go in hand with inefficient overinvestment. While liquidity transformation can lead to macroeconomic instability in the form of multiple equilibria, aggregate consumption is higher than in a cash-only economy, regardless of which equilibrium is selected. |
| Keywords: | Banks, Liquidity, Monetary policy, Zero-lower bound |
| JEL: | E4 E5 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:snb:snbwpa:2025-04 |
| By: | Stefano Grassi (University of Rome Tor Vergata, Italy); Marco Lorusso (University of Perugia, Italy; Newcastle University Business School, UK); Francesco Ravazzolo (BI Norwegian Business School, Norway; Free University of Bozen-Bolzano, Italy; RCEA) |
| Abstract: | We propose and estimate an open economy general equilibrium model that includes international trade between Canada and the US. For both countries, we consider a rich fiscal policy sector with two different types of public expenditure: productive and unproductive government spending. We estimate our model using a new adaptive methodology based on the Mixture of Student's t by Importance Sampling weighted Expectation-Maximization (MitISEM). Our findings regarding the Canadian economy indicate that, irrespective of the type of government expenditure, an increase in domestic public spending leads to an improvement of the domestic trade balance. Notably, we find that the domestic real exchange rate appreciates in response to a positive shock in the domestic unproductive government expenditure, whereas it depreciates after an increase in the domestic productive government spending. Our analysis indicates that a decrease in trade openness, for example resulting from a possible trade war, has important consequences for the propagation of productive and productive government spending shocks on the economy. |
| Keywords: | Open-Economy Model; Fiscal Policy; Adaptive Importance Sampling; ExpectationMaximization. |
| JEL: | E62 F41 C12 C22 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:bzn:wpaper:bemps111 |
| By: | Aliaksandr Zaretski (University of Surrey) |
| Abstract: | I study the optimal regulation of a financial sector where individual banks face self-enforcing constraints countering their default incentives. The constrained-efficient social planner can improve over the unregulated equilibrium in two dimensions. First, by internalizing the impact of banks’ portfolio decisions on the prices of assets and liabilities that affect the enforcement constraints. Second, by redistributing future net worth from new entrants to surviving banks, which increases the current forward-looking value of all banks, relaxing their enforcement constraints and decreasing the probability of banking crises. The latter can be accomplished with systemic preemptive bailouts that are time consistent and unambiguously welfare improving. Unregulated banks can be both overleveraged and underleveraged depending on the state of the economy, thus macroprudential policy requires both taxes and subsidies, while minimum bank capital requirements are generally ineffective. |
| JEL: | E44 E60 G21 G28 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:sur:surrec:0325 |
| By: | Jordi Galí; Davide Debortoli |
| Abstract: | We provide an empirical assessment of a central implication of models with idiosyncratic income risk and incomplete markets: the existence of a role for the distribution of wealth in shaping the dynamics of aggregate consumption. Estimates of consumption Euler equation models extended to include wealth distribution statistics show the latter to have a negligible quantitative impact on aggregate consumption. This contrasts with the important role played by current disposable income, even when we use data for households with (relatively) high liquid wealth. The latter finding suggests the presence of a significant behavioral component behind the high sensitivity of consumption to current income. |
| Keywords: | HANK models, idiosyncratic income risk, incomplete markets, representative household, TANK models |
| JEL: | E21 E32 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:bge:wpaper:1484 |
| By: | Cremer, Helmuth; Gahvari, Firouz |
| Abstract: | This study contributes to the long-term care policy literature by exploring how, in an uncertain environment, redistributive tax policies and long-term care program design interact with informal care incentives, shaping long-term caregiving outcomes. The analysis is done within an overlapping-generations model in the steady state under full and asymetric information. Altruistic children provide informal care to their elderly parents if dependent. Not all children are altruistic. Children’s level of altruism is shaped by the time and attention they received in childhood. Key findings, under asymetric information, include: (i) Allocations are distorted for redistributive purposes, except for savings, (ii) marginal income tax rates are positive, aligning with standard nonlinear income taxation models, and (iii) a consequence of government’s redistributive policies is to encourage time spent with children thus incresing family caregiving. These three findings apply to both “opting out” and “topping up” schemes. (iv) Savings must be subsidized in an opting out system due to fiscal externalities; (v) if public assistance carries a stigma, it may have to be distorted upward; the opting-out policy welfare dominates the topping-up policy. Finally, if long term care provision carries no stigma, opting out is more cost-effective than topping up in both first- and second-best. |
| Keywords: | Long term care; uncertain altruism; opting out; topping up; public insurance |
| JEL: | H2 H5 |
| Date: | 2025–03–13 |
| URL: | https://d.repec.org/n?u=RePEc:tse:wpaper:130430 |