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on Dynamic General Equilibrium |
| By: | Coenen, Günter; Mazelis, Falk; Motto, Roberto; Ristiniemi, Annukka; Smets, Frank; Warne, Anders; Wouters, Raf |
| Abstract: | This chapter of the Research Handbook of Inflation (2025) reviews the evolution and current relevance of medium-scale New Keynesian Dynamic Stochastic General Equilibrium (DSGE) models, which serve as part of the core analytical framework in central banks and academic macroeconomics. The chapter assesses their capacity to analyse inflation dynamics, monetary transmission mechanisms, and policy interventions. Despite their exclusion of crisis-specific features, canonical models such as Smets and Wouters (2007) continue to explain inflation and output dynamics in the euro area and the US, owing in part to the differentiated effects of cost-push and demand shocks and the mitigating role of monetary policy. The chapter traces advancements in the European Central Bank’s New Area-Wide Model (NAWM), highlighting extensions that incorporate financial frictions, effective lower bounds, and energy price shocks. These enhancements have strengthened the model’s forecasting performance and interpretative power, especially during periods of unconventional monetary policy and energy-driven inflation. DSGE models are shown to be particularly effective for policy counterfactuals, enabling real-time assessments of policy decisions relative to model-based optimal policy. A robustness analysis under alternative scenarios demonstrates how policy rules can be evaluated through a welfare lens, informing the design of resilient monetary frameworks. Finally, the chapter identifies key modelling challenges exposed by recent inflation episodes and advocates for richer supply-side structures and nonlinear dynamics to improve the models’ capacity to capture complex macroeconomic developments. JEL Classification: E31, E32, E52, E58, C63 |
| Keywords: | effective lower bound, forecast evaluation, inflation dynamics, optimal policy, policy counterfactuals |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbwps:20253137 |
| By: | Matthias Burgert; Giulio Cornelli; Burcu Erik; Benoit Mojon; Daniel Rees; Matthias Rottner |
| Abstract: | This paper introduces the BIS Multisector Model (BIS-MS), a dynamic stochastic general equilibrium (DSGE) model for analyzing macroeconomic dynamics in a multi-sector production network. The model can be calibrated to match the input-output data of more than 80 economies, enabling a detailed exploration of sectoral interdependencies and cross-industry shock transmission. By incorporating nominal rigidities at the sectoral level, the model can also be used to evaluate alternative monetary policy strategies. The paper demonstrates the model's capabilities by analyzing temporary and permanent energy price shocks under different monetary policy frameworks. In doing so, it illustrates the critical role of the country-specific production networks in shaping macroeconomic outcomes. The accompanying model toolbox equips policymakers and researchers with an easy-to-access platform for flexible scenario analysis. |
| Keywords: | multisector model, DSGE model, monetary policy, production network, climate change |
| JEL: | C54 E52 H23 Q43 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:bis:biswps:1297 |
| By: | Masashige Hamano (Waseda University, School of Political Science and Economics); Yuki Murakami (Waseda University, Graduate School of Economics) |
| Abstract: | This paper highlights the potential for decoupling economic growth from CO2 emissions under strong policy, while providing a tractable framework for analyzing the long-run global green transition. We develop a dynamic stochastic general equilibrium model with heterogeneous firms: green firms abate emissions at higher costs, while brown firms do not. Emissions reduce aggregate productivity but are not internalized in competitive equilibrium. Using global data from 1981 to 2022, we calibrate the model to match observed trends in GDP and emissions. The analysis delivers three main findings. First, while emissions continue to rise, the share of green firms grows over time. Second, faster technological progress amplifies the growth–emissions trade-off, whereas slower progress attenuates it. Third, welfare analysis shows that the optimal emission tax must be substantially higher than current levels, though its role is moderated when combined with abatement innovation. Together, these results underscore the importance of policy in sustaining growth while mitigating environmental externalities. |
| Keywords: | Climate change, Green transition, Heterogeneous firms, Economic growth, DSGE models |
| JEL: | Q54 Q58 E32 F44 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:wap:wpaper:2522 |
| By: | Marlon Azinovic-Yang; Jan \v{Z}emli\v{c}ka |
| Abstract: | We develop a deep learning algorithm for approximating functional rational expectations equilibria of dynamic stochastic economies in the sequence space. We use deep neural networks to parameterize equilibrium objects of the economy as a function of truncated histories of exogenous shocks. We train the neural networks to fulfill all equilibrium conditions along simulated paths of the economy. To illustrate the performance of our method, we solve three economies of increasing complexity: the stochastic growth model, a high-dimensional overlapping generations economy with multiple sources of aggregate risk, and finally an economy where households and firms face uninsurable idiosyncratic risk, shocks to aggregate productivity, and shocks to idiosyncratic and aggregate volatility. Furthermore, we show how to design practical neural policy function architectures that guarantee monotonicity of the predicted policies, facilitating the use of the endogenous grid method to simplify parts of our algorithm. |
| Date: | 2025–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2509.13623 |
| By: | Wongkot Similan Rujiwattanapong |
| Abstract: | Standard search theory predicts that (1) job search intensity increases with the relative gain from searching, and (2) job search intensity increases the job finding probability. Firstly, this paper presents new empirical findings that are at odds with these predictions when workers are categorised by their unemployment insurance (UI) history. UI recipients and former recipients search harder than those who never take up UI, yet they exhibit lower job-finding probabilities. Subsequently, I incorporate unproductive and inefficient job search, consistent with these empirical findings, into an otherwise standard stochastic equilibrium search-and-matching model with endogenous search intensity. Three key results emerge from these job search imperfections: (1) aggregate search intensity becomes acyclical leading to underestimated matching efficiency; (2) the general equilibrium effects of UI extensions and the labour market fluctuations are dampened; and (3) unemployment and its duration become more persistent. |
| Keywords: | Business cycles; Job search intensity; Matching efficiency; Unemployment insurance; Unemployment dynamics |
| JEL: | E24 E32 J24 J64 J65 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:pui:dpaper:240 |
| By: | Jake Bradley; Junggie Lee |
| Abstract: | This paper studies the heterogeneous distributional effects of trade liberalization. We develop a tractable heterogeneous agent general equilibrium model in which individuals differ by income, wealth, age, and employment status, while firms endogenously evolve in productivity following a stochastic process with fixed export costs. In the model, trade openness raises the return to labor and deepens the capital stock, lowering returns on assets. These shifts generate systematic differences in preferences over trade: workers whose income relies primarily on labor gain from openness, while retirees and asset-dependent households may lose. Using microdata from the Brexit referendum in the United Kingdom, we document empirical patterns consistent with the model’s predictions: individuals with higher labor income shares were significantly less likely to support leaving the European Union. By linking micro-level heterogeneity to macro-level trade outcomes, the model offers a useful tool for evaluating the political economy and welfare consequences of globalization. |
| Keywords: | Trade gains; Heterogeneous agent; Perpetual youth; Life-cycle |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:not:notcfc:2025/02 |
| By: | Felix Kubler (University of Zurich); Simon Scheidegger (University of Lausanne - School of Economics and Business Administration (HEC-Lausanne); London School of Economics, Grantham Research Institute on Climate Change and the Environment); Oliver Surbek (University of Lausanne - Department of Economics (DEEP)) |
| Abstract: | We develop a computational framework for deriving Pareto-improving and constrained optimal carbon tax rules in a stochastic overlapping generations (OLG) model with climate change. By integrating Deep Equilibrium Networks for fast policy evaluation and Gaussian process surrogate modeling with Bayesian active learning, the framework systematically locates optimal carbon tax schedules for heterogeneous agents exposed to climate risk. We apply our method to a 12-period OLG model in which exogenous shocks affect the carbon intensity of energy production, as well as the damage function. Constrained optimal carbon taxes consist of tax rates that are simple functions of observables and revenue-sharing rules that guarantee that the introduction of the taxes is Pareto improving. This reveals that a straightforward policy is highly effective: a Pareto-improving linear tax on cumulative emissions alone yields a 0.42% aggregate welfare gain in consumption-equivalent terms while adding further complexity to the tax provides only a marginal increase to 0.45%. The application demonstrates that the proposed approach produces scalable tools for macro-policy design in complex stochastic settings. Beyond climate economics, the framework offers a template for systematically analyzing welfare-improving policies in various heterogeneous-agent problems. |
| Keywords: | Climate Policy, Optimal Policy, Ramsey Taxation, Pareto Frontier, Deep Learning, Gaussian Processes |
| JEL: | C61 C63 D58 H23 Q54 Q58 |
| Date: | 2025–07 |
| URL: | https://d.repec.org/n?u=RePEc:chf:rpseri:rp2582 |
| By: | Juan Passadore; Giovanni Sciacovelli; Ms. Filiz D Unsal; Carlos van Hombeeck |
| Abstract: | We present an Open Economy HANK model with relevant features for Low-Income Countries (LICs): hand-to-mouth households and a subsistence consumption for tradable goods. With the model calibrated for a representative LIC, we illustrate our broader framework with a shock to external prices. The shock causes a consumption-led recession, an increase in inflation and a drop in real wages. Consumption inequality rises: poor households cannot insure against the shock, unlike richer households who can tap into their wealth. Monetary policy is unable to substantively improve poorer households’ welfare, due to offsetting effects on real wages and labor demand. Simulations of the effects of alternative monetary policy responses on inequality yield similar findings. In this setting, fiscal transfers are a more effective tool for redistribution across households. |
| Keywords: | Monetary Policy; Inequality; Open Economy HANK; Low-income Countries |
| Date: | 2025–10–03 |
| URL: | https://d.repec.org/n?u=RePEc:imf:imfwpa:2025/204 |
| By: | Hai Ha Pham (EM Normandie); Ngoc-Sang Pham (EM Normandie) |
| Abstract: | We investigate the effects of wariness (defined as individuals' concern for their minimum utility over time) on poverty traps and equilibrium multiplicity in an overlapping generations (OLG) model. We explore conditions under which (i) wariness amplifies or mitigates the likelihood of poverty traps in the economy and (ii) it gives rise to multiple intertemporal equilibria. Furthermore, we conduct comparative statics to characterize these effects and to examine how the interplay between wariness, productivity, and factor substitutability influences the dynamics of the economy. |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2510.14418 |
| By: | Barreto, Cesar (OECD, Paris); Merkl, Christian (University of Erlangen-Nuremberg) |
| Abstract: | Our paper documents the importance of ex ante worker heterogeneity for labor market dynamics and for the composition of the unemployment pool over the business cycle. In recessions, the unemployment pool shifts toward workers with higher wages in their previous jobs. Based on administrative data for Germany and two-way worker and firm wage fixed effects, we show that this shift is mainly connected to worker heterogeneity, not to firm heterogeneity. We calibrate a search and matching model with ex ante worker heterogeneity to the estimated relative residual wage dispersion across worker fixed-effect groups. We show that a lower idiosyncratic match-specific shock dispersion for high-wage workers is key for the larger relative fluctuations of their separation rate as well as for the positive co-movement between prior wages and fixed effects of unemployed workers with aggregate unemployment. We argue that firm-based explanations, such as cyclical financial frictions, are unlikely to be key drivers for the documented empirical patterns. |
| Keywords: | labor market flows, separations, fixed effects, labor market dynamics |
| JEL: | E24 J16 J31 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:iza:izadps:dp18162 |
| By: | Emil Bandoni; Carolina Fugazza |
| Abstract: | Medical expenditures increase sharply with age and can impose a significant finan- cial risk on the elderly, even in settings with universal health insurance. In particular, out-of-pocket medical spending remains highly skewed, with a small fraction of indi- viduals facing catastrophic costs. This paper develops a life-cycle model in which rare, idiosyncratic health shocks generate substantial out-of-pocket expenses late in life. The model demonstrates that accounting for these rare health disasters can explain the moderate risk-taking behavior observed among older investors, without invoking be- quest motives. These findings highlight the importance of tail medical risks in shaping late-life financial decisions. |
| Keywords: | life-cycle portfolio choice, disaster risk, beta distribution, out-of-pocket medical spending |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:cca:wpaper:748 |
| By: | Jean-Paul L’Huillier; Pierlauro Lopez; Sanjay R. Singh |
| Abstract: | Motivated by behavioral evidence, we develop a tractable method for incorporating competition neglect in a general equilibrium firm investment problem. Competition neglect causes firms to systematically underestimate the investment of their competitors. When we introduce competition neglect into a canonical RBC model, this friction acts like an investment wedge that causes overinvestment at first, and underinvestment later on. In contrast to a model with exogenous investment shocks, these dynamics are accompanied by realistic variation in equity premia, even in the absence of financial frictions. Investment booms raise stock prices in general equilibrium, predicting periods of low excess returns going forward. The model can generate realistic comovement of real and financial variables. |
| Keywords: | animal spirits; boom-bust cycles; Behavioral macroeconomics |
| JEL: | E22 E32 D21 D91 |
| Date: | 2025–10–08 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedfwp:101905 |
| By: | Matias Moretti (University of Rochester); Lorenzo Pandolfi (University of Naples Federico II and CSEF); Sergio L. Schmukler (World Bank Research Department); Tomas Williams (George Washington University); German Villegas-Bauer (International Monetary Fund) |
| Abstract: | We study how investor demand influences government borrowing capacity, default risk, and bond prices. We develop a sovereign debt model with a rich demand structure, featuring investors with asset-allocation mandates. In our framework, bond prices depend not only on government policies and default risk, but also on investor composition and demand elasticity. We estimate this elasticity from bond price responses to the periodic rebalancing of a major emerging markets bond index, which shifts investors’ allocations. We calibrate the model using this estimate and show that a downward-sloping demand acts as a disciplining device that mitigates debt dilution by curbing future issuance. This market-based mechanism lowers default risk and allows the government to sustain higher debt. Unlike standard models, where discipline arises from default penalties, our mechanism operates through investor behavior. This distinction matters for policy: with market discipline in place, fiscal rules have milder effects on borrowing and default risk. |
| Keywords: | sovereign debt, inelastic investors, disciplining device, debt dilution, fiscal rules |
| JEL: | F34 F41 G15 |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:anc:wmofir:192 |
| By: | Bachmann, Ruediger; Born, Benjamin; Goldfayn-Frank, Olga; Kocharkov, Georgi; Luetticke, Ralph; Weber, Michael |
| Abstract: | We exploit Germany's temporary three-percentage-point VAT cut in the second half of 2020 to study the spending response to unconventional fiscal policy. We use survey and scanner data on household consumption expenditures and their perceived pass-through of the tax change into prices, and a RANK model to quantify the effects of this VAT policy. The survey and scanner data show that the temporary VAT reduction led to a relative increase in durable and, to a lesser extent, semidurable spending for individuals with high perceived pass-through. According to the RANK model, the VAT policy increased total aggregate consumption spending by 4.4 percent on impact. |
| Keywords: | unconventional fiscal policy, value added tax, survey data, expectations, consumption, durables, RANK model |
| JEL: | D12 E20 E21 E62 E65 R31 |
| Date: | 2025 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bubdps:328247 |
| By: | Ricardo Alonzo Fern\'andez Salguero |
| Abstract: | This paper presents SIMPOL (Simplified Policy Iteration), a modular numerical framework for solving continuous-time heterogeneous agent models. The core economic problem, the optimization of consumption and savings under idiosyncratic uncertainty, is formulated as a coupled system of partial differential equations: a Hamilton-Jacobi-Bellman (HJB) equation for the agent's optimal policy and a Fokker-Planck-Kolmogorov (FPK) equation for the stationary wealth distribution. SIMPOL addresses this system using Howard's policy iteration with an *upwind* finite difference scheme that guarantees stability. A distinctive contribution is a novel consumption policy post-processing module that imposes regularity through smoothing and a projection onto an economically plausible slope band, improving convergence and model behavior. The robustness and accuracy of SIMPOL are validated through a set of integrated diagnostics, including verification of contraction in the Wasserstein-2 metric and comparison with the analytical solution of the Merton model in the no-volatility case. The framework is shown to be not only computationally efficient but also to produce solutions consistent with economic and mathematical theory, offering a reliable tool for research in quantitative macroeconomics. |
| Date: | 2025–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2509.23557 |
| By: | Leandro Lyra Braga Dognini |
| Abstract: | I characterize stochastic non-t\^atonnement processes (SNTP) and argue that they are a natural outcome of General Equilibrium Theory. To do so, I revisit the classical demand theory to define a normalized Walrasian demand and a diffeomorphism that flattens indifference curves. These diffeomorphisms are applied on the three canonical manifolds in the consumption domain (i.e., the indifference and the offer hypersurfaces and the trade hyperplane) to analyze their images in the normalized and the flat domains. In addition, relations to the set of Pareto optimal allocations on Arrow-Debreu and overlapping generations economies are discussed. Then, I derive, for arbitrary non-t\^atonnement processes, an Attraction Principle based on the dynamics of marginal substitution rates seen in the "floor" of the flat domain. This motivates the definition of SNTP and, specifically, of Bayesian ones (BSNTP). When all utility functions are attractive and sharp, these BSNTP are particularly well behaved and lead directly to the calculation of stochastic trade outcomes over the contract curve, which are used to model price stickiness and markets' responses to sustained economic disequilibrium, and to prove a stochastic version of the First Welfare Theorem. |
| Date: | 2025–09 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2509.17248 |
| By: | Criscent Birungi; Cody Hyndman |
| Abstract: | We consider the problem of optimal annuitization with labour income, where an agent aims to maximize utility from consumption and labour income under age-dependent force of mortality. Using a dynamic programming approach, we derive closed-form solutions for the value function and the optimal consumption, portfolio, and labor supply strategies. Our results show that before retirement, investment behavior increases with wealth until a threshold set by labor supply. After retirement, agents tend to consume a larger portion of their wealth. Two main factors influence optimal annuitization decisions as people get older. First, the agent's perspective (demand side); the agent's personal discount rate rises with age, reducing their desire to annuitize. Second, the insurer's perspective (supply side); insurers offer higher payout rates (mortality credits). Our model demonstrates that beyond a certain age, sharply declining survival probabilities make annuitization substantially optimal, as the powerful incentive of mortality credits outweighs the agent's high personal discount rate. Finally, post-retirement labor income serves as a direct substitute for annuitization by providing an alternative stable income source. It enhances the financial security of retirees. |
| Date: | 2025–10 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2510.10371 |