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on Dynamic General Equilibrium |
| By: | Takemasa Oda (Director and Senior Economist, Institute for Monetary and Economic Studies, Bank of Japan (currently, Japan Center for Economic Research, E-mail: takemasa.oda@jcer.or.jp)) |
| Abstract: | This paper quantitatively evaluates the long-run effects of changes in inflation on the real economy, with a focus on deflation and population aging in Japan. It develops an overlapping generations model that incorporates household demand for safe assets. The model features two channels through which a decline in inflation affects the real economy in the long run, that is, the Mundell-Tobin effect and the redistribution effect. Calibrated to the Japanese economy, the model shows that a decline in inflation does more damage to young households and impairs capital accumulation, thus reducing output and social welfare, and moreover, that the damage can be magnified by population aging. This result could provide a certain rationale for central banks to pursue and maintain a positive rate of inflation in an aging economy. |
| Keywords: | Demographics, life cycle, deflation, Mundell-Tobin effect, redistribution, overlapping generations model |
| JEL: | E21 E31 J11 |
| Date: | 2024–11 |
| URL: | https://d.repec.org/n?u=RePEc:ime:imedps:24-e-14 |
| By: | C. LABROUSSE (Insee, Paris School of Economics); Y. PERDEREAU (Paris School of Economics) |
| Abstract: | What are the effects of central bank balance sheet expansion, and should we worry about central bank losses? Using a Heterogeneous Agent New Keynesian model incorporating money in utility and an endogenous zero lower bound (ZLB), we study the fiscal-monetary interaction of central bank balance sheet policies. We find that the overall efficiency of asset purchase programmes depends on the combination of the expected future size of the balance sheet and the fiscal transmission of central bank losses. First, permanent balance sheet expansions stimulate the economy in the long-run and, by anticipation, increase inflation and output during the ZLB episode, as they interact with distortionary taxes and imperfect capital markets. Second, at the end of the ZLB, the central bank incurs losses: issuing securities to offset these losses is more welfare-enhancing than raising taxes. |
| Keywords: | monetary policy heterogeneous agents, balance sheet, Quantitative Easing, Quantitative Tightening, Central Bank losses, fiscal and monetary policy mix |
| JEL: | E21 E41 E51 E52 E58 E63 E65 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:nse:doctra:2025-10 |
| By: | Efrem Castelnuovo; Giovanni Pellegrino; Laust L. Særkjær |
| Abstract: | We study how uncertainty shocks affect the macroeconomy across the inflation cycle using a nonlinear stochastic volatility-in-mean VAR. When inflation is high, uncertainty shocks raise inflation and depress real activity more sharply. A non-linear New Keynesian model with second-moment shocks and trend inflation explains this via an 'inflation-uncertainty amplifier': the interaction between high trend inflation and firms' upward price bias magnifies the effects of uncertainty by increasing price dispersion. An aggressive policy response can replicate the allocation achieved under standard policy when trend inflation is low. |
| Keywords: | uncertainty, trend inflation, nonlinear VAR model, new Keynesian model, monetary policy. |
| JEL: | C32 E32 E44 G01 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_11853 |
| By: | Matteo Ghilardi; Roy Zilberman |
| Abstract: | We examine the macroeconomic, asset pricing, and public debt consequences of deficit financing dividend taxation in a dynamic general equilibrium model featuring partial investment irreversibility. Dividend taxes interact directly with the occasionally-binding irreversibility constraint, generating tax-augmented user-cost and hangover channels that both shape investment and debt-to-output fluctuations and account for a sizeable share of their long-run volatilities. Our analysis further reveals that debt-offsetting dividend tax hikes initially trigger investment inactivity through higher user-costs, followed by a surge driven by intertemporal tax arbitrage and hangover effects. Finally, debt-driven dividend tax rules amplify asset price fluctuations while delivering only modest fiscal revenue changes. |
| Keywords: | Dividend Taxation; Investment Frictions; Asset Prices; Deficit Financing; Public Debt. |
| Date: | 2025–05–02 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/083 |
| By: | Akira Ishide (The University of Tokyo) |
| Abstract: | Aggregate production and total factor productivity (TFP) fall dramatically during sudden stop episodes. During these episodes, domestic demand contracts, while foreign demand remains largely stable, and exchange rate depreciation favors exporters. This shift leads to a relative expansion of export-oriented activities over domestic-oriented activities. Due to a combination of differences in market power and tax treatment, export-oriented activities exhibit lower revenue-based TFP (TFPR) than domestic-oriented activities. Consequently, the reallocation of resources toward export-oriented activities reduces aggregate TFP. Leveraging detailed microdata from Mexico, I provide new empirical evidence demonstrating the difference in distortions and reallocations of resources at the plant–product–destination level during the 1994 sudden stop. I then build a multisector small open economy new Keynesian model and show that reallocation effects explain about 50% of the observed decline in value added in the manufacturing sector. |
| Date: | 2025–05 |
| URL: | https://d.repec.org/n?u=RePEc:cfi:fseres:cf602 |
| By: | Huixin Bi; Andrew Foerster; Nora Traum |
| Abstract: | Using a two-country monetary union framework with financial frictions, we quantify the efficacy of targeted asset purchases, as well as expectations of such programs, in the presence of sovereign default and financial liquidity risks. The risk of default increases with the level of government debt and shifts in investors’ perception of fiscal solvency. Liquidity risks increase when the probability of default affects the tightness of credit markets. We calibrate the model to Italy during the 2012 European debt crisis and compare it to key features of the data. We find that changes in investors’ perception played a more significant role than increases in government debt in affecting the macroeconomy. When a debt crisis occurs, asset purchases help stabilize both financial markets and the economy. This stabilization effect can occur even if asset purchases are expected but never implemented. Moreover, expectations of potential asset purchases during a crisis alter the level of economic activity in periods when there are no crises. |
| Keywords: | fiscal policy; monetary policy; unconventional monetary policy; Monetary Union; financial frictions; Regime-Switching Models |
| JEL: | E58 E63 F45 |
| Date: | 2025–05–07 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedfwp:99977 |
| By: | Pedro Henrique Alves Pereira |
| Abstract: | This paper examines optimal inflation targeting, determining the best inflation target and policy response using a DSGE model with adaptive price-setting firms, in the form of a hybrid Phillips Curve. The results indicate a zero inflation target maximizes household welfare, as higher inflation increases volatility and economic inefficiency. As inflation targets rise, monetary policy must respond more aggressively to shocks and deviations from the target. Notably, the optimal policy does not react to output gaps. These findings highlight the importance of credible and well-structured monetary policies in ensuring macroeconomic stability and the growing costs of inflation (in terms of households’ welfare). |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:bcb:wpaper:623 |
| By: | Andrian, Leandro Gaston; Leon-Diaz, John; Rojas, Eugenio |
| Abstract: | We examine hedging as a macroprudential tool in a Sudden Stops model of an economy exposed to commodity price fluctuations. We find that hedging commodity revenues yields significant welfare gains by stabilizing public expenditure, which heavily depends on these revenues. However, this added stability weakens precautionary motives and exacerbates the pecuniary externality that drives overborrowing in such models. As a result, hedging and traditional macroprudential policy act as complements rather than substitutes, with more ag- gressive hedging inducing a stronger macroprudential response. Our findings suggest that while hedging enhances stability and improves welfare, it does not eliminate the need for macroprudential regulation. |
| Keywords: | Hedging;Sudden stops;Financial Crises;Macroprudential policy |
| JEL: | F32 F41 G13 |
| Date: | 2025–04 |
| URL: | https://d.repec.org/n?u=RePEc:idb:brikps:14083 |
| By: | SUMIZAWA, Kazui |
| Abstract: | This study examines public pension reform in a small open economy model where households fully finance education. Departing from previous studies that assume fully publicly funded education, we introduce loan interest subsidies on education in the presence of intergenerational transmission of human capital, which enables an earlier phase-out of pay as-you-go (PAYG) pensions in a Pareto-improving way. We extend the analysis to a closed economy where wages and interest rates are endogenously determined. By incorporating general equilibrium effects through factor prices, we show that loan interest subsidies make a Pareto-improving, gradual reduction of PAYG pensions feasible even in closed economies. This result highlights the efficiency gains from linking pension reform with educational loan support, in contrast to prior studies that overlook private education spending or factor price adjustments. |
| Keywords: | intergenerational transmission, human capital, loan interest subsidies, pay-as-you-go pension, pension reforms |
| JEL: | E62 H23 H55 |
| Date: | 2025–04–30 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:124645 |
| By: | Hagiwara, Takefumi |
| Abstract: | This study theoretically analyzes population aging and its impacts on economic growth, wealth inequality, and fiscal sustainability. We introduce lifetime uncertainty to the overlapping generations model with heterogeneous households with varied intertemporal preferences, where unintended bequests caused by death are inherited by offspring. Aging can have both positive and negative impacts on economic growth and fiscal sustainability: saving-enhancing effects based on the life cycle theory and wealth-depletion effects caused by extended longevity. When aging advances, saving-enhancing effects are offset by wealth-depletion effects, which eventually outweigh the former. The results show an “inverted U-shaped” relationship between life expectancy and economic growth rate, or fiscal sustainability. Numerical simulation reveals that aging can produce a trade-off between economic growth and wealth inequality. We also show that a rise in deficit or government expenditure ratios exacerbate fiscal instability, economic growth, and wealth inequality under certain conditions. |
| Keywords: | Population Aging; Secular Stagnation; Inequality; Fiscal Sustainability |
| JEL: | D63 H63 J14 O11 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:124598 |
| By: | Piyali Das; Chetan Ghate; Subhadeep Halder |
| Abstract: | We develop a dynamic model of monetary-fiscal interactions and government debt. We introduce a novel channel of fiscal dominance through the maturity structure. Faced with an expansionary fiscal policy shock, extending debt-maturity under fiscal dominance becomes a strategic tool for maintaining debt sustainability without immediate price-level adjustments by the monetary authority. We show that extending the maturity of debt raises the interest burden of debt. To validate the results empirically, we assemble a novel central government security level dataset between 1999-2022 for India. We find that the probability of issuing a long-term security is approximately 7 percentage points higher in a fiscal dominant regime compared to a monetary dominant regime. Using the approach in Hall and Sargent (2011) for debt-decomposition, we show that the nominal return on marketable and non-marketable debt is the largest component driving public debt increases in periods of fiscal dominance between 1999-2022. Our paper highlights the ’maturity-structure’ channel of fiscal dominance, and provides a framework to quantify the impact of fiscal dominance on the interest-rate burden of sovereign debt in a large emerging market economy. |
| Keywords: | debt decomposition, fiscal dominance, monetary-fiscal interactions, macroeconomic stabilization |
| JEL: | E43 E61 E63 E65 H63 O23 |
| Date: | 2025–05 |
| URL: | https://d.repec.org/n?u=RePEc:een:camaaa:2025-29 |
| By: | Rodolfo E. Manuelli |
| Abstract: | In their celebrated 1981 paper "Some Unpleasant Monetarist Arithmetic, " Sargent and Wallace show that when a central bank is required to transfer resources to the fiscal authority, it faces a trade-off: if it chooses to keep inflation low in the short run, then it must be willing to accept higher inflation in the long run. In this paper I characterize the optimal interest rate (and inflation) policy by a central bank faced with a version of the Sargent-Wallace scenario. I explore this question in a setting in which a certain amount has to be transferred for an uncertain period of time. I find that uncertainty makes the optimal policy to deviate from a Barro-like martingale behavior of taxes or a Lucas-Stokey type of solution where the tax (or distortion) inherits the properties of the stochastic process for transfers. The optimal nominal interest rate (and inflation) is such that the central bank chooses to issue debt (e.g., reverse repos) instead of raising the required amount of seigniorage. Initially inflation is lower than what would be required to raise enough resources to pay for the transfer plus the interest on existing debt. The intuition for this result is that the monetary authority is taking advantage of an option: if the transfer period is short, then (relatively) low inflation today can spread the losses over time. Over time, as the debt increases, more revenue has to be raised. Interest rates increase. The time path of inflation depends on whether the monetary authority can “inflate away” part of the debt. If this default is costly, the end of the transfer period is associated with permanently lower inflation. If a sudden increase in the price level (default) is an option (and if it chooses to be exercised), the end of the transfer period is associated with high (and brief) inflation and then stabilization. |
| Keywords: | optimal monetary policy; inflation; fiscal dominance |
| JEL: | E5 E6 |
| Date: | 2025–04–02 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedlwp:99980 |