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on Dynamic General Equilibrium |
| By: | Biagio Rosso; Matteo Gatto |
| Abstract: | The role of Occasionally Binding Constraints (OBCs) in transmitting and amplifying macroeconomic shocks in economies institutionally chracterised by market-incompleteness is of increasing interest to quantitative theory and policy. This paper presents a novel framework and iterative algorithm to efficiently formulate and solve for transitional dynamics in a wide class of heterogeneous agent DSGE (HA-DSGE) models with OBCs. The framework accommodates a wide range of constraints, such as policy bounds, without requiring any specific assumptions as to the form of the aggregate shocks must take at an equilibrium solution, and is modelunspecific, marking a departure from the methodological literture on the topic. More imporantly, it preserves key nonlinearities often lost in perturbation-based methods important to retain for a more granular analysis of the interaction between agent heterogeneity and OBCs and its implications for modelling policy transmission through the distribution. In particular, the nonlinearity arising from the interaction, in a rational expectations and forward-looking setting, between the endogenous regime sequence (whether the constraint binds) and the behaviour of heterogeneous agents. The proposed Double Shooting algorithm novelly integrates the Sequence- Space OccBin approach with an iterative and informationally efficient method for solving nonlinearly HA-DSGE models in the sequence space that exploits the availability of a Directed Acyclic Graph (DAG) to efficiently partition the system of equations holding at a sequence space equilibrium and generalising the solution procedure for deterministic transition paths familiar from KS modelling. The algorithm developed is then applied to a fully-fledged one-asset HANK model with a zero lower bound (ZLB) on interest rate. The analysis highlights how wealth distributional dynamics along the transition path can critically influence monetary policy effectiveness (and vice versa) both outside and especially at the ZLB. Thereby, we highlight through the potential role of unconventional redistributive fiscal measures and fiscal forward guidance in addressing recessionary-deflationary episodes, converging in a rich quantitative setting to intuitions familiar from the Keynesian and Post-Keynesian literatures. |
| Keywords: | Heterogeneous Agents DSGE, Occasionally Binding Constraints, Liquidity Trap, In- equality and Monetary Policy, Unconventional Fiscal-Monetary Policy |
| JEL: | C63 D31 E21 E32 E52 E60 E63 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:pke:wpaper:pkwp2511 |
| By: | Mr. Zamid Aligishiev; Michael Ben-Gad; Joseph Pearlman |
| Abstract: | We present alternative methods for calculating and interpreting the influence of exogenous shocks on historical episodes within the context of DSGE models. We show analytically why different methods for calculating shock decompositions can generate conflicting interpretations of the same historical episodes. We illustrate this point using an extended version of Drautzburg and Uhlig’s (2015) model of the U.S. economy, focusing on the periods 1964–1966, 1979–1987, 2006–2009, 2016–2020 and 2020–2023. We argue that the best method for analyzing particular episodes is one which isolates the influence of the shocks during the period under consideration and where the initial conditions represent the system’s distance from balanced growth path at the beginning of the episode. |
| Keywords: | DSGE model; Shock Decomposition; Financial Frictions; Fiscal Policy |
| Date: | 2025–03–07 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/051 |
| By: | Pedemonte, Mathieu; Toma, Hiroshi; Verdugo, Esteban |
| Abstract: | We explore the implications of heterogeneous, history-dependent inflation expectations in a general equilibrium setting. We propose an experience-based expectations-augmented Kalman filter to represent consumers' heterogeneous inflation expectations, where heterogeneity arises from an anchoring-to-the-past mechanism. Using survey data, we show that the model replicates US consumers' inflation expectations and their heterogeneity across cohorts. We introduce this mechanism into a New Keynesian model and find that heterogeneous expectations anchor aggregate responses to the agents' inflation history, producing sluggish expectations dynamics. Central banks should be active to prevent inflationary episodes that agents will remember far into the future. |
| Keywords: | Belief formation;Heterogeneous expectations;survey data;Overextrapolation |
| JEL: | D84 E31 E58 E71 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:idb:brikps:14068 |
| By: | Thomas Lejeune (Economics and Research Department, National Bank of Belgium); Jolan Mohimont (Economics and Research Department, National Bank of Belgium) |
| Abstract: | We extend the reference DSGE model used for policy analysis at the NBB with a financial sector, by incorporating multi-period fixed-rate corporate and mortgage loans, an imperfect pass-through from policy rates to the deposit rate, and bank capital re-quirements. Adding multi-period fixed-rate loans amplifies the propagation of default risks and strengthens the effectiveness of macroprudential policy. This amplification operates through a bank capital channel and a market timing effect that delays borrowing and investment when rates are expected to fall. The bank capital channel also propagates shocks across sectors, and amplifies the effects of monetary policy when the duration of banks’ assets is larger than that of their liabilities. With universal banks, that grant both corporate and mortgage loans, sectoral prudential policy instruments can have unintended consequences on credit supply in the untreated sector. These crowding out effects increase with the loan duration in the treated sector and decrease with the risk weight differential between the treated and untreated sectors. Finally, we apply our model to the mortgage risk weight add-on introduced by the NBB in 2013. |
| Keywords: | Macroprudential policy, credit risks, loan maturity, financial accelerator, sectoral spillovers, unintended consequences, DSGE. |
| JEL: | E3 E44 E5 G21 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:nbb:reswpp:202504-474 |
| By: | Andres Rodriguez-Clare; Mauricio Ulate; Jose P Vasquez |
| Abstract: | We present a dynamic quantitative trade and migration model that incorporates downward nominal wage rigidities and show how this framework can generate changes in unemployment and labor participation that match those uncovered by the empirical literature studying the "China shock". We find that the China shock leads to average welfare increases in most U.S. states, including many that experience unemployment during the transition. However, nominal rigidities reduce the overall U.S. gains by around two thirds. In addition, there are 18 states that experience welfare losses in the presence of downward nominal wage rigidity that would have experienced gains without it. |
| Keywords: | trade, unemployment, China shock, downward nominal wage rigidity |
| Date: | 2025–03–25 |
| URL: | https://d.repec.org/n?u=RePEc:cep:cepdps:dp2088 |
| By: | Uquillas, Carlos Alfredo |
| Abstract: | This article examines how economic narratives, such as those emerging from business communication, the media, and economic authorities, affect economic behavior and agents' decisions. Based on Keynes' theory of "animal spirits" and Robert Shiller's work on the influence of narratives, a model is proposed in which narratives can directly influence macroeconomic variables such as consumption, investment, and income. Through an applied approach, it suggests how to integrate narrative variables into IS-LM and DSGE models to better understand their effects on the economic cycle. The article also discusses how "confidence" and other narrative expectations affect economic activity and how authorities could incorporate this concept into their analysis and policy formulation. |
| Keywords: | Narrative Economics, Economic Confidence, Economic Cycle, IS-LM Model, DSGE Model, Expectations, Narrative Contagion, Animal Spirits, Narrative Hysteresis, Rational Expectations. |
| JEL: | D83 E32 E44 E50 |
| Date: | 2025–02–12 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:124040 |
| By: | Snigdha Kalra (Indira Gandhi Institute of Development Research); Sargam Gupta (Indira Gandhi Institute of Development Research) |
| Abstract: | This paper explores the possible ways in which the emerging market and developing economies (EMDEs) can improve their tax-to-GDP ratio using a theoretical framework. We do this using a Laffer curve analysis at the balanced growth path. We develop a closed-economy discrete-time neoclassical growth model with heterogeneous agents, and three sectors: households, firms, and the government. This model is calibrated for a typical EMDE and it incorporates two well-documented features that limit their tax capacity. The first feature we model is the presence of a large proportion of the economy that neither pays nor files taxes. To address this, our model includes heterogeneous agents, represented by Ricardian and non-Ricardian households. Non-Ricardian households belong to the informal sector and are entirely exempt from taxes, while Ricardian households may choose to comply with tax obligations, creating a partially endogenous framework for tax evasion. The second critical feature is the relative weakness of institutions in the EMDEs as compared to the advanced economies (AEs). We incorporate aspects such as the probability of audits, penalties for evasion, and the culture of corruption in a minimalist way to capture the essence of the realities of weak institutions. We derive the expression for the Laffer curve for three types of taxes: the labour income tax, the capital income tax, and the consumption tax. We find that the fiscal policies attuned towards bringing a higher percentage of agents under the ambit of tax collection - despite households evading taxes - significantly boost the tax revenues. The model clearly shows that countries with weaker institutions will have a lower tax capacity, as any increase in the tax rates reduces tax compliance and increases tax evasion. Finally, reducing the income tax exemptions, decreasing the share of informal sector firms and employees, and strengthening the institutional quality are essential for improving the fiscal space in the EMDEs. To our knowledge, no coherent neoclassical growth model exists in the literature that effectively captures these features within EMDEs. |
| Keywords: | Laffer curve, Optimal taxes, Growth models, Heterogeneous Agents, Institutions, Tax Evasion |
| JEL: | E02 E13 E62 H21 H26 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:ind:igiwpp:2025-007 |
| By: | Yuanchen Cai (Boston College); Pablo Guerron-Quintana (Boston College) |
| Abstract: | This paper studies the macroeconomic consequences of asymmetric interest rate shocks at which small open economies borrow in international financial markets. Empirically, we document that borrowing spreads have two distinct regimes. The first one features stable borrowing rates, i.e., low risk. In contrast, the second phase displays large spreads with significant volatility and –asymmetry, high risk. We fit the spreads to a rich statistical process that allows for changes in the level, volatility, skewness and kurtosis of the spread’s distribution. Each of the spread regimes is estimated to be highly persistent. When we embed the estimated spreads in a standard small-open economy model, we find that 1) spread shocks alone explain a large fraction of the volatility in consumption and investment in the data; 2) interest shocks of similar magnitude have stronger contractionary effects in an economy where only low risk exists than in one with changes between high and low risk; 3) the transition from an economy with only low-risk interest rate shocks to one like in the data results in a significant and persistent contraction. The welfare cost of this transition equals 2.4% of consumption. Finally, an unexpected increase in skewness pushes the economy into a recession with output, consumption, and investment dropping by as much as 1%, 2%, and 5%, respectively. This contraction resembles those experienced by developing countries during sudden stop episodes. |
| Keywords: | Borrowing spreads, risk, skewness, business cycles, welfare cost, sudden stops |
| JEL: | F4 C2 |
| Date: | 2025–04–16 |
| URL: | https://d.repec.org/n?u=RePEc:boc:bocoec:1088 |
| By: | Tumisang Loate; Vincent Dadam |
| Abstract: | This paper investigates the effect of commodity price shocks in a commodity-exporting small open economy, and the role of fiscal policy in transmitting these shocks to the rest of the economy. Using South African data, we first estimate an empirical model using a Bayesian vector autoregression model. We then develop a New Keynesian small open economy with labour market hysteresis and commodity price shocks. We find that a commodity price shock typically has an expansionary effect as real GDP and employment increase, which translates into higher tax revenue. |
| Keywords: | Fiscal policy, Commodity trading, Price shocks |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:unu:wpaper:wp-2025-22 |
| By: | Manning, Alan |
| Abstract: | This paper takes the canonical Burdett-Mortensen model of wage-posting and relaxes the assumption that wages are set once-for-all, instead assuming they can only be committed one period at a time. It derives a closed-form solution for a steady-state Markov Rank-Preserving Equilibrium and shows how this relates to the canonical model and performs some comparative statics on it. But it is shown that a Rank-Preserving Equilibrium may fail to exist because employers have more monopsony power over existing workers than new recruits and that this non-existence can be a problem for plausible parameter values. It is shown how a Rank-Inverting Equilibrium may exist. It is argued that this problem is likely to occur in a wide range of search models. |
| Keywords: | wage-posting; search; monopsony |
| JEL: | R14 J01 J1 |
| Date: | 2025–03–20 |
| URL: | https://d.repec.org/n?u=RePEc:ehl:lserod:127471 |