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on Dynamic General Equilibrium |
| By: | Ioana Moldovan; Shu-Chun S. Yang; Luis-Felipe Zanna |
| Abstract: | This paper examines Ramsey-optimal policies related to fiscal spending and international reserve accumulation in response to volatile aid flows in Low-Income Countries (LICs). We develop a real Dynamic Stochastic General Equilibrium (DSGE) model of a small open economy, incorporating government transfers and public investment as fiscal spending components, along with two prominent characteristics of LICs: Dutch disease (DD) externalities and financially constrained households. Driven by considerations of precautionary saving, Ramsey-optimal policies involve partial reserve accumulation and partial fiscal spending of aid. Stronger DD externalities necessitate greater reserve ac- cumulation to stabilize future output, thereby mitigating consumption volatility. While transfers directly support private consumption smoothing, public investment also con- tributes to this goal by sustaining future income through gradual capital accumulation. Higher aid volatility calls for increased public investment, underscoring the role of public capital accumulation as a precautionary saving instrument, beyond its developmental role discussed in the literature. |
| Keywords: | aid; fiscal policy; reserve policy; foreign exchange intervention; optimal policy; low-income countries |
| Date: | 2025–08–01 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/154 |
| By: | Mihaylovski, Peter |
| Abstract: | This paper explores how policies that allow lenders to pursue borrowers for remaining debt after mortgage foreclosure (mortgage recourse) influence key aspects of the housing market and the broader macroeconomy. To this end, I develop a dynamic stochastic general equilibrium (DSGE) model featuring savers and borrowers, strategic default behavior on housing debt, and an endogenous loan-to-value (LTV) ratio. The analysis indicates that real house prices, LTV ratios, and mortgage debt levels increase with greater recourse tightness, while mortgage spreads decline. Default rates also increase with stricter recourse, despite more severe penalties targeting borrowers' assets beyond their housing collateral. In addition, mortgage recourse amplifies the volatility of key financial variables - such as LTV ratios, default rates, and mortgage spreads - intensifying financial cycles. Finally, mortgage recourse appears to be welfare-enhancing only for savers, as it provides an insurance-like mechanism in the event of borrower default. These findings underscore the complex tradeoffs involved in mortgage recourse policies, offering important insights into their role in shaping housing markets and, more broadly, economic stability. |
| Keywords: | DSGE, housing, recourse |
| JEL: | E32 E44 G01 R31 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:uhhwps:323580 |
| By: | Christian Bayer; Alexander Kriwoluzky; Gernot J. Müller; Fabian Seyrich |
| Abstract: | Attitudes toward fiscal policy differ: fiscal conservatism and fiscal liberalism vary in their willingness to tolerate budget deficits. We challenge the view that such attitudes reflect national preferences. Instead, we offer an economic explanation based on a two-country Heterogeneous Agent New Keynesian model, bringing its implicit political economy dimension to the forefront. We compute the welfare implications of alternative fiscal policies at the household level to assess the conditions under which a policy commands majority support. Whether the majority supports fiscal conservatism or liberalism depends on a country’s debt level, its wealth distribution, and the nature of the economic shock. |
| Keywords: | HANK, two-country model, political economy, government debt, fiscal policy, household heterogeneity |
| JEL: | E32 H63 F45 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:diw:diwwpp:dp2132 |
| By: | Ruthira Naraidoo (University of Pretoria, Hatfield 0028, Pretoria, South Africa); Juan Paez-Farrell (School of Economics, University of Sheffield, Sheffield S10 2TU, UK) |
| Abstract: | Standard business cycle models with search and matching frictions in the labour market increasingly rely on the assumption that firms face hiring, as opposed to, search costs in recruiting workers. We show that although this modification im-proves the model’s empirical performance, it causes the matching function to play no role in macroeconomic dynamics. Assuming both costs can overcome this short-coming but for reasonable parameter values it implies that matching efficiency shocks have no effects. |
| Keywords: | DSGE models; Labour market; search and matching; unemployment; hiring costs |
| JEL: | E32 C52 J64 |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:shf:wpaper:2025006 |
| By: | van der Kwaak, Christiaan (University of Groningen) |
| Abstract: | In this paper, we investigate the long-run effects from central bank bond purchases onfinancial stability within a New Keynesian DSGE model with financial frictions. Banks havea portfolio choice between safe government bonds and risky corporate securities, and aresubject to limited liability. Bond purchases by the central bank induce banks to shift fromsafe bonds to risky securities, thereby increasing the probability of insolvency, everythingelse equal. However, bond purchases also lead to capital gains on banks’ existing assets, which reduces banks’ reliance on deposits. Moreover, a lower return on banks’ assets (asa result of the bond purchases by the central bank) decrease banks’ profitability, therebydecreasing depositors’ willingness to let banks operate with high leverage ratios. Our keyconclusion is that bond purchases also enhance financial stability in the long-run. |
| Date: | 2024 |
| URL: | https://d.repec.org/n?u=RePEc:gro:rugfeb:2024013-eef |
| By: | Bušs, Ginters; Traficante, Guido |
| Abstract: | This paper studies monetary policy in a New Keynesian model with incomplete information regarding the persistence of cost-push shocks. The central bank and the private sector gradually learn about the persistence of the shock as it propagates through the economy. The central bank adopts a look-through policy in response to temporary cost-push shocks; otherwise, it follows a Taylor rule. If agents initially believe the cost-push shock to be temporary, while the true shock is persistent, it takes some time for the central bank, acting initially under an incorrect assumption, to realise its mistake and switch to monetary tightening. As a result, the actual inflation is higher than in a complete information case. Data-dependent discretionary early liftoff strategies can partially mitigate the effects of the initial policy misjudgment. Contrary to the full-information conditions, the findings cast doubt on the effectiveness of look-through policies in environments of incomplete information, irrespective of the actual persistence of the cost-push shock. |
| Keywords: | monetary policy; imperfect information; cost-push shock; high inflation |
| JEL: | D83 E17 E31 E47 E52 |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:cpm:dynare:085 |
| By: | John B. Donaldson; Hyung Seok E. Kim; Rajnish Mehra |
| Abstract: | We develop a dynamic macroeconomic model in which the secular decline in real interest rates arises endogenously from rising wealth inequality. Challenging the standard “safe asset shortage” hypothesis, the model shows how falling real rates can coexist with a stable safe asset ratio—closely matching U.S. empirical patterns. The mechanism combines limited financial market participation, which concentrates capital ownership among a shrinking class of stockholders, with egalitarian wage bargaining, which generates time-varying labor income shares under incomplete markets. As inequality increases, stockholders face higher financial and operating leverage, increasing their consumption volatility and precautionary demand for bonds. At the same time, greater wage instability raises workers’ demand for safe assets. The resulting surge in precautionary savings from both groups depresses real returns and creates the appearance of a safe asset shortage, despite an unchanged supply. This outcome reflects a pecuniary externality: agents fail to internalize the aggregate constraint on safe assets, especially over the business cycle. Our calibrated model reproduces key macro-financial patterns and offers new insights into the joint dynamics of wealth distribution, labor market arrangements, and asset pricing. |
| JEL: | D31 D52 E13 E21 E24 E32 E43 E44 G1 G12 J41 J63 J64 |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:34016 |
| By: | Selahattin Imrohoroglu; Daniel Carroll; Sewon Hur; Braden Strackman |
| Abstract: | In this paper, we use an overlapping generations-standard incomplete markets model to quantitatively investigate the long-run implications of Koreas demographic changes and policy reforms. Importantly, our quantitative model endogenizes the retirement decision and matches the elasticity of retirement to wealth. Optimal policy likely combines reforms such as increasing the retirement age, higher taxes, or changes to retirement benefits. We use the model calibrated to Koreas economy and demography as a quantitative laboratory to investigate two policy scenarios: increasing taxes or decreasing benefits. While decreasing benefits leads to great long run activity, it comes at the cost of lower average welfare, particularly for retirees. |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:cnn:wpaper:25-017e |
| By: | Volha Audzei; Sergey Slobodyan |
| Abstract: | This paper studies convergence properties, including local and global strong E-stability, of the rational expectations equilibrium (REE) under non-smooth learning dynamics, and the role of monetary policy in agents' expectation formation. In a New Keynesian model, we consider two types of informational constraints that operate jointly - Sparse Rationality under Adaptive Learning. We study the dynamics of the learning algorithm for the positive costs of attention, initialized from the equilibrium with mis-specified beliefs. We find that, for any initial beliefs, the agents' forecasting rule converges either to the Minimum State Variable (MSV) REE, or, for large attention costs, to a rule with anchored inflation expectations. With stricter monetary policy the convergence is faster. A mis-specified forecasting rule that uses a variable not present in the MSV REE does not survive this learning algorithm. We apply the theory of non-smooth differential equations to study the dynamics of our learning algorithm. |
| Keywords: | Bounded rationality, expectations, learning, monetary policy |
| JEL: | D84 E31 E37 E52 |
| Date: | 2025–06 |
| URL: | https://d.repec.org/n?u=RePEc:cnb:wpaper:2025/9 |
| By: | Volha Audzei; Jan Bruha; Ivan Sutoris |
| Abstract: | In this paper, we study domestic and foreign monetary policy transmission in a small open economy in which firms can decide to hold foreign currency loans (FCLs). In a workhorse two-country DSGE model, firms borrow in advance to cover production costs and choose the share of FCLs based on interest rate differentials and expected exchange rate movements. In this framework, we further examine how FCL holdings affect the transmission of exogenous shocks and monetary policy. The results indicate that FCLs impact the effectiveness of domestic policy depending on the shock type: they strengthen monetary policy transmission in response to domestic shocks, while weakening it in response to asymmetric foreign and exchange rate shocks. Symmetric global supply shocks reduce domestic policy efficacy, requiring higher rates to curb inflation but causing larger output losses. In contrast, global demand shocks allow for less aggressive domestic policy responses under large FCL holdings. |
| Keywords: | Cost channel of monetary policy, dynamic stochastic general equilibrium models, foreign currency loans, small open economy |
| JEL: | E32 E44 E52 F41 |
| Date: | 2025–06 |
| URL: | https://d.repec.org/n?u=RePEc:cnb:wpaper:2025/10 |
| By: | Liu, K.; Mogstad, M.; Salvanes, K. G. |
| Abstract: | We measure the returns to education in the presence of earnings uncertainty and employment risk over the life cycle. The context of our study is Norway, offering a credible instrument for schooling and population panel data with nearly career long earnings histories. We first characterize the causal relationship between schooling, earnings, and employment over the life cycle. This relationship allows us draw conclusions about how additional schooling affects the probability of having a job as well as the level and dispersion of earnings over the life cycle. To disentangle uncertainty from heterogeneity, we next model the underlying earnings process, targeting the estimated causal relationship between schooling, earnings, and employment over the life cycle. We then fit a life-cycle model with precautionary saving motive to the estimated earnings process and observed consumption profiles. The estimated model allows us to quantify how earnings uncertainty and employment risk affect the incentives to invest in education, and to examine the extent to which the progressive tax-transfer system distorts these incentives. |
| Keywords: | Returns to Education, life-Cycle Earnings, Income Uncertainty, Employment Risk, Precautionary Savings |
| JEL: | I26 J24 J31 D91 |
| Date: | 2025–06–30 |
| URL: | https://d.repec.org/n?u=RePEc:cam:camdae:2549 |
| By: | Christoffel, Kai; Farkas, Mátyás |
| Abstract: | This paper investigates the implications of a potential loss of credibility in the central bank’s ability to bring inflation back to target in the medium-term (”de-anchoring”). We propose a monetary policy framework in which the central bank accounts for de-anchoring risks using a regime-switching model. First, we derive the optimal monetary policy strategy, which balances the trade-off between the welfare costs of a stronger response to inflation and the benefits of preserving the central bank’s credibility. Next, we apply this framework in a medium-scale regime-switching DSGE model and develop a method to assess de-anchoring risks in real time. Using the post-COVID inflation episode in the euro area as a case study, we find that an explicit ”looking-through” strategy would have only modestly increased de-anchoring risks. These findings highlight the importance of monitoring de-anchoring risks in monetary policy design. JEL Classification: D83, D84, E10 |
| Keywords: | DSGE estimation, inflation de-anchoring, regime switching |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbwps:20253082 |
| By: | Delis, Manthos; Iosifidi, Maria |
| Abstract: | We develop a model of green lending to study its implications for monetary policy and environmental regulation. Banks finance firms’ brown and/or green projects. The costs of brown projects increase with rising regulatory stringency or when endogenous monetary policy affects the cost of funds. Both policies can elevate the equilibrium share of green lending, resulting in greener output. Our findings remain consistent when we introduce central banks with an explicit green objective (e.g., differential interest rates based on project type), forward-looking bank behavior, and adjustment costs. Additionally, we demonstrate the relative impacts of regulatory and monetary persistent regime changes. |
| Keywords: | Green lending; Green monetary policy; Environmental regulation |
| JEL: | E44 E52 G21 Q50 |
| Date: | 2025–06–25 |
| URL: | https://d.repec.org/n?u=RePEc:pra:mprapa:125118 |
| By: | Joris Tielens (National Bank of Belgium, Research Department) |
| Abstract: | We study the interconnection between the productivity and pricing effects of financial shocks. Combining administrative records on firm-level output prices and quantities with quasi-experimental variation in credit supply, we show that a tightening of credit conditions has a persistent, yet delayed, negative effect on firms’ long-run physical productivity growth (TFPQ) but also induces firms to change their pricing policies. Commonly used revenue-based productivity measures (TFPR)—which conflate price and productivity—offer biased predictions regarding the consequences of financial shocks for firms’ productivity growth, underestimating the long-run elasticity of physical productivity to credit supply by half. We also show that the pricing adjustments themselves have productivity implications. Firms use low pricing as a source of internal financing, allowing them to avoid cutting expenditures on productivity-enhancing activities, thereby softening the impact of financial shocks. We incorporate these forces into a quantitative model of firm dynamics to quantify the importance of productivity and pricing dynamics (and their interplay) in driving the scarring effects of financial crises on aggregate productivity and welfare. |
| Keywords: | productivity, pricing, financial constraints, innovation |
| JEL: | D22 D24 E31 E44 G01 |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:nbb:reswpp:202507-479 |
| By: | Andrés Nicolás Herrera-Rojas; David Camilo López-Valenzuela; Juan J. Ospina-Tejeiro; Jesús Bejarano |
| Abstract: | Fiscal policy and monetary policy are intricately connected, as government policies influence various macroeconomic variables, affecting prices and, consequently, Central Bank decisions. To elucidate this relationship, this document outlines the model employed by Banco de la República’s technical staff to analyze and quantify the impact of fiscal policy on key macroeconomic variables, featuring a detailed fiscal structure that distinguishes it from other models. Furthermore, as an illustration of the analyses conducted with this model, the document presents a simulation that assumes an increase in the risk premium, examining two potential responses the government might consider under tighter financial conditions: adjusting public investment to comply with the fiscal rule, or not adjusting public expenses and incurring in additional debt, leading to non-compliance with the fiscal rule. When the adjustment involves reducing public investment, domestic demand, inflation, and the monetary policy rate decrease. Conversely, financing the revenue shortfall with public debt, thereby failing to comply with the fiscal rule, exacerbates negative effects on private demand. *****RESUMEN: La política fiscal y la política monetaria están estrechamente relacionadas, debido a que las diferentes medidas fiscales adoptadas tienen un efecto sobre el resto de las variables macroeconómicas, afectando los precios y con ello las decisiones del Banco Central. Para entender mejor esta relación, en este documento se muestra el modelo de equilibrio general usado por el Banco de la República para analizar y cuantificar el impacto de la política fiscal sobre las principales variables económicas y que a diferencia de otros modelos incluye un detallado bloque fiscal. Adicionalmente, como parte de los análisis realizados con el modelo, se presenta un ejercicio de simulación que supone un incremento de la prima de riesgo, explorando dos caminos alternativos que el gobierno podría llevar a cabo: ajustar el gasto de inversión para cumplir con la regla fiscal o no ajustar el gasto y recurrir a mayor deuda, lo cual conllevaría a un incumplimiento de la regla fiscal. Cuando el ajuste se hace por medio de una reducción en la inversión pública, la demanda doméstica, la inflación y la tasa de interés son menores. Sin embargo, financiar el menor ingreso por medio de un mayor endeudamiento, incumpliendo la regla fiscal, profundiza los efectos negativos sobre la demanda privada. |
| Keywords: | Risk premium, fiscal adjustments, dynamic stochastic general equilibrium model, fiscal rule, Prima de riesgo, ajuste fiscal, modelo de equilibrio general dinámico estocástico, regla fiscal |
| JEL: | E44 E62 E63 H30 |
| Date: | 2025–08 |
| URL: | https://d.repec.org/n?u=RePEc:bdr:borrec:1324 |
| By: | Mervin Goklas Hamonangan |
| Abstract: | This study contributes to the discussion about how higher public debt may not be costly because of the negative interest rate-growth differentials by simulating OLG models introduced by Blanchard (2019) under uncertainty, showing debt and welfare dynamics in two scenarios: intergenerational transfers and debt rollovers in the case of Indonesia. The simulation is done by modifying the model parameters based on interest rate-growth differentials historic data from 2004-2019. It is found that the fiscal consensus does not hold when implementing Blanchard (2019) analysis with Indonesian-based rate parameters. Increasing public debt makes the economy more volatile and high risk. Modifying other factors supports the initial finding, with lower initial endowment diminishing the benefits of public debt and higher capital share under Cobb-Douglas. When the threat of debt explosion appears, efforts to reduce debt share will reduce the welfare of the society. The policy implication is to be careful of the opportunity. Increasing public debt may not be the way to go, avoiding possible dire consequences. |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2507.18092 |