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on Dynamic General Equilibrium |
| By: | George-Marios Angeletos; Chen Lian; Christian K. Wolf; Dalton Rongxuan Zhang |
| Abstract: | The possibility of fiscal dominance in the representative-agent New Keynesian model (RANK) hinges on the assumption that income is perpetually demand-determined: fiscal deficits can drive output and inflation within that model only insofar as they trigger infinitely lasting, self-sustained shifts in aggregate spending and income. Moving to heterogeneous-agent New Keynesian models (HANK) opens the door to a different pathway: classical non-Ricardian effects, due to finite horizons or liquidity constraints. A refinement motivated by the model's intended focus on short-run phenomena—requiring a return to flexible-price outcomes in finite time—arrests the infinite feedback loop between spending and income, leaving only the classical non-Ricardian mechanism, and makes sure that the study of monetary-fiscal interactions is not centered on hard-to-test assumptions regarding beliefs at infinity. |
| JEL: | E5 E6 |
| Date: | 2026–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35642 |
| By: | Cristiano Cantore; Matteo Gatto; Francesco Saverio Gaudio; Pascal Meichtry |
| Abstract: | This paper studies how the prevailing level of public debt shapes the transmission of fiscal and monetary policy shocks in a tractable heterogeneous three-agent New Keynesian model. When households rely on the liquidity services of government bonds to self-insure against idiosyncratic risk, higher public indebtedness amplifies the deterioration in debt sustainability after expansionary government spending shocks. In such economies, fiscal expansions weaken precautionary bond demand, requiring the central bank to keep real interest rates higher for longer and thereby raising debt servicing costs and narrowing fiscal space. By contrast, the transmission of monetary expansions is largely invariant to the initial debt level, as such shocks have little effect on the insurance value of government bonds. These results highlight the central role of the liquidity premium and self-insurance motive in linking initial public indebtedness to long-run fiscal sustainability. |
| Keywords: | Monetary–Fiscal Interactions, Heterogeneity, Liquidity, Self-Insurance, Government Debt, Debt Sustainability |
| JEL: | E21 E52 E58 E62 E63 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:bfr:banfra:1055 |
| By: | Manuel Gloria (Bank of England); Chiara Punzo (Bank of England) |
| Abstract: | We develop a DSGE model that incorporates state-dependent commercial bank capital requirements as a source of non-linearity. The presence of non-bank financial institutions (NBFI) amplifies the contractionary effects of monetary policy, primarily through the asset price channel. The amplification effect is strongest in the left tail of the GDP distribution and remains pronounced under zero lower bound conditions. The short-run vulnerabilities exposed by NBFIs contrast with their long-run benefits: a greater share of NBFI lending is associated with higher welfare. |
| Keywords: | Non-bank financial institutions;financial frictions;bank capital;macroprudential policy;monetary policy;GDP-at-risk |
| JEL: | E32 E58 G23 |
| Date: | 2025–11–21 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023278 |
| By: | Jamie Lenney (Bank of England); Biagio Rosso (University of Cambridge) |
| Abstract: | This paper proposes a flexible approach to departing from full information rational expectations (FIRE) in DSGE models using the sequence space framework. We implement a reduced-form behavioural expectations process in which agents can simultaneously overreact or underreact to current economic conditions and underreact to news, and we derive an associated behavioural expectations solver deployable to a wide class of DSGE and HANK models. The approach nests several different expectations models as special cases while remaining agnostic on the precise source of belief frictions. We apply it to a medium-scale two-asset HANK model and jointly estimate the model’s dynamic and behavioural parameters on US business cycle data, including inflation expectation data. Behavioural expectations quantitatively improve the empirical fit of the model and the qualitative properties of its impulse response functions. |
| Keywords: | Behavioural expectations;HANK models;sequence space;monetary policy;information rigidity;asymmetric attention;macroeconomic transmission;business cycle estimation;DSGE. |
| JEL: | D84 E31 E52 E70 |
| Date: | 2026–07–17 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023319 |
| By: | Joshua Coven; Sebastian Golder; Arpit Gupta; Abdoulaye Ndiaye |
| Abstract: | Low property taxes amplify lock-in among elderly homeowners, limiting housing access for young families. Raising them reallocates housing toward the young through two channels: capitalization into lower prices reduces required downpayments for financially constrained buyers, a form of embedded leverage, while higher tax obligations raise holding costs for older owners. In our overlapping generations model, raising California’s property taxes to Texas levels increases young homeownership while decreasing elderly homeownership. Removing step-up basis also lowers elderly homeownership, suggesting their tenure is sustained by bequest tax advantages. The tax treatment of housing shapes housing allocation across generations. |
| JEL: | H24 H71 J11 R21 |
| Date: | 2026–08 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35587 |
| By: | Vedanta Dhamija (Bank of England); Ricardo Nunes (University of Surrey); Roshni Tara (Bank of England) |
| Abstract: | Housing is a closely monitored and prominent sector for households. We find that households in the United States tend to overweight house price expectations when forming inflation expectations with a coefficient of 25%–45%, significantly above the weight of house prices in the inflation index. We first use two data sets, a multitude of controls, and an instrumental variable approach to address endogeneity. We then use a second strategy based on household heterogeneity. As expected, we find a significant effect of numeracy skills and whether households moved house recently. We model this household behaviour in a two-sector New Keynesian model with an overweighted and a non-overweighted sector and show that overweighted sectors are disproportionately more important for monetary policy. |
| Keywords: | Salience;inflation expectations;house price expectations;monetary policy |
| JEL: | D10 E12 E31 E52 E58 |
| Date: | 2026–01–23 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023291 |
| By: | Hylton Hollander (University of Cape Town); Clinton Joel (National Treasury) |
| Abstract: | Most inflation-targeting central banks target a small but positive underlying rate of inflation, often called trend inflation1. Yet its appropriate level remains uncertain. The extended deliberation in South Africa to move from a 3 - 6% target band to a 3% point target (with a ±1% tolerance band) illustrates this tension. In our working paper (Trend Inflation and the Costs of Price Dispersion in a Fiscal DSGE Model), we examine the role of trend inflation in an economy and argue that, all else equal, lower trend inflation is better for the economy. |
| Keywords: | Trend inflation, monetary policy, price dispersion, Phillips curve, sacrifice ratio |
| JEL: | E30 E52 |
| Date: | 2026–01 |
| URL: | https://d.repec.org/n?u=RePEc:rza:ersawp:275 |
| By: | Mridula Duggal (Bank of England) |
| Abstract: | This paper studies how inflation expectations respond to monetary-policy regime changes. I develop a New Keynesian model with trend inflation and adaptive learning in which adopting inflation targeting (IT) is a downward shift in the central bank’s inflation objective. Under rational expectations, expected inflation adjusts on impact. Under adaptive learning, beliefs update gradually and expectations adjust only partially between announcement and implementation. I then use professional-forecaster surveys for 32 countries and exploit staggered IT adoption to trace expectations and realised inflation around regime transitions. Empirically, inflation declines following adoption, while survey expectations exhibit little systematic adjustment. The results indicate that inflation leads expectations, at odds with the canonical New Keynesian rational-expectations prediction, and imply that – following the adoption of IT – credibility can be built over time as policy delivers lower inflation outcomes. |
| Keywords: | Inflation expectations;monetary policy;subjective expectations;adaptive learning;inflation;regime shifts |
| JEL: | D83 D84 E52 E58 |
| Date: | 2026–03–20 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023297 |
| By: | Burkhard Heer; Mark Trede |
| Abstract: | We develop a medium-scale overlapping-generations model with endogenous labour supply and skill premium to study optimal income redistribution using progressive labour income taxes and pensions. The model is calibrated to the four countries USA, Great Britain, Italy and Germany which differ substantially in their tax and pension systems, demographics, and skill shares among workers. Optimal pension benefits are proportional to lifetime contributions in all four countries, while the optimal degree of income progressivity varies systematically with country characteristics such as the size of the social security system, demographics or the skill share in the labour force. Optimal income taxes should be more progressive in the United States and Great Britain and much less progressive in the continental countries, Italy and Germany. Population ageing further reduces the optimal extent of income redistribution. |
| Keywords: | inequality, income distribution, skill premium, overlapping generations, social security, progressive taxation, pension schedule |
| JEL: | C68 D31 H21 H24 H55 J11 J26 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_12938 |
| By: | Edoardo Maria Acabbi; Andrea Alati; Luca Mazzone |
| Abstract: | Using administrative data, we document that workers acquire more human capital at more productive firms. Recessions distort workers-firm sorting, flatten the job ladder and impact human capital accumulation, as workers match on average to worse firms. To quantify the aggregate relevance of these effects, we build a directed search model with aggregate risk and worker-firm heterogeneity, in which human capital accumulation depends on firm quality. We estimate the model and show that recessions have persistent negative effects on the productivity of worker-firm matches, with distortions in sorting and human capital accumulation accounting for approximately 35% of cumulative output losses. |
| Date: | 2026–07 |
| URL: | https://d.repec.org/n?u=RePEc:arx:papers:2607.29210 |
| By: | Jenny Chan (Bank of England); Sebastian Diz (Central Bank of Paraguay); Derrick Kanngiesser (Independent Researcher) |
| Abstract: | We study a New Keynesian model where production inputs and pricing decisions are made under information frictions. Firm production is constrained by inputs that are chosen before shocks are realized, based on firms’ expectations of future demand. We show that the assumption of real rigidities versus nominal rigidities is not innocuous, as assuming the presence of either or both affects the pass-through of demand shocks to aggregate output and inflation. When the choice of production inputs is made under imperfect information about demand shocks, the impact on inflation is amplified while the impact on output is dampened. When both production inputs and pricing decisions are made under imperfect information about demand shocks, the pass-through to output is amplified while the impact on inflation is dampened. Additionally, we show that expectations about demand can behave similarly to a supply shock, as these expectations influence the natural level of output and enter the New Keynesian Phillips curve in a manner analogous to a cost-push shock. Empirical evidence suggests that inflation falls following a positive surprise in industrial production, consistent with the model version featuring real rigidities. |
| Keywords: | Information frictions;New Keynesian;real rigidities |
| JEL: | E31 E31 E52 E58 |
| Date: | 2025–11–21 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023277 |
| By: | Aurélien Espic |
| Abstract: | This paper examines how heterogeneous capital pledgeability shapes capital allocation. I first document, using French firm-level data, that firms holding more pledgeable capital are structurally more leveraged and display greater sensitivity of investment to credit supply shocks. I then incorporate heterogeneous capital pledgeability into a general equilibrium model with collateral constraints. This feature creates sectoral capital misallocation: high-pledgeability capital is less costly to accumulate and thus yields lower expected returns than low-pledgeability capital, both in steady state and in response to credit supply shocks. I estimate the model based on a simple distinction between commercial real estate and other types of capital goods, the former being more pledgeable. I then show that capital misallocation is substantial over the credit cycle. Because these capital goods are imperfect substitutes and firms face a unique interest rate, redistributive credit policies taxing debt issued by high-pledgeability firms while subsidizing that of less pledgeable firms raise welfare, particularly when implemented during a credit expansion. |
| Keywords: | Capital Pledgeability, Capital Misallocation, Credit Policies |
| JEL: | E44 E58 E61 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:bfr:banfra:1058 |
| By: | Brigitte Hochmuth; Christian Merkl; Heiko Stüber |
| Abstract: | This paper studies how an unemployment-benefit reform in one member state of a monetary union affects savings, net foreign asset positions, and fiscal space across member states when households face incomplete insurance. Lower benefits reduce unemployment and increase fiscal space in the reforming country. Employed workers increase their precautionary savings to compensate for reduced public insurance. A portion of these savings is invested abroad, pushing the non-reforming country into a negative net foreign asset position and lowering its long-run consumption. Despite raising fiscal space and long-run average consumption in the reforming country, the reform may decrease ex-ante welfare because it reduces insurance and depresses consumption during the transition as households self-insure through higher savings. We discipline our proposed model with firm-level evidence on Germany’s post-reform tradable-sector expansion following the Hartz IV reform of unemployment benefits. In our simulation, this reform accounts for a substantial share of the observed post-reform open-economy adjustment, whereas the earlier wage moderation cannot explain most of the observed patterns. |
| Keywords: | unemployment insurance reform, spillover effects, precautionary savings |
| JEL: | E21 E24 F16 F41 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_12934 |
| By: | Sandra Batten (Bank of England and Durham University Business School); Stephen Millard (NIESR, Durham University Business School and Portsmouth University) |
| Abstract: | In this paper, we use a dynamic general equilibrium model to examine the effect of the move to net zero in the United Kingdom on productivity. One argument is that the transition is likely to be productivity-reducing, as it will involve a move from more to less efficient means of producing. Alternatively, it could be argued that the transition will be productivity-enhancing, as the capital investment required to bring about this move leads to a rise in productivity, both within the specific ‘greening’ industries and more generally via productivity spillovers to the rest of the economy. Our model enables us to examine how this potential trade-off varies depending on whether we look at the short, medium or long run. We find that the introduction of a carbon tax, applied to encourage the move towards net zero, reduced GDP and total hours worked, but since total hours fell by more than GDP, increased productivity. As electricity becomes more substitutable for petrol and gas, the effect on productivity becomes more positive as GDP recovers while total hours remain permanently lower than initially. Finally, our results suggest that unless investment in green technology leads to significant technological gains elsewhere, it is unlikely that the move to net zero will have a large effect on productivity growth above and beyond the direct effect resulting from the capital deepening that will be associated with it. |
| Keywords: | Climate change;dynamic general equilibrium;carbon tax;climate policy;energy;renewable energy |
| JEL: | Q28 Q38 Q43 Q48 Q58 E32 |
| Date: | 2026–02–13 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023293 |
| By: | Tomas Key (Bank of England); Matthew McKernan (Bank of England); Bradley Speigner (Bank of England) |
| Abstract: | Cyclical movements in labour market slack depend not only on job losses and hiring, but also on which workers find themselves unemployed at different points in time and how likely they are to remain in the labour force. Using data from the UK Labour Force Survey (LFS), we show that the procyclicality in the rate at which unemployed workers leave the labour force is strongly correlated with compositional changes in the unemployment pool. Workers who enter unemployment following job loss are substantially less likely to exit the labour force than workers who enter unemployment from inactivity. We document that whether an unemployed worker was previously employed or inactive is the strongest predictor of their attachment to the labour market, and show that this is not explained by variation in search effort. Motivated by these findings, we extend a Diamond-Mortensen-Pissarides search-and-matching model to allow for heterogeneous labour market attachment among the unemployed. Fluctuations in job separations change the composition of the unemployment pool and amplify unemployment fluctuations relative to the standard model. Quantitatively, this mechanism increases unemployment volatility by around 50%, and helps the model account for the sharp rise in unemployment at the onset of the Great Recession. |
| Keywords: | Labour force participation;Unemployment;search and matching;search intensity |
| JEL: | E24 E32 J21 J64 |
| Date: | 2026–04–02 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023300 |
| By: | Thomas Drechsel (University of Maryland, NBER, CEPR); Michael McLeay (Bank of England); Silvana Tenreyro (London School of Economics); Enrico D Turri (London School of Economics) |
| Abstract: | We show that the optimal monetary policy and exchange rate framework depend critically on the economy’s commodity exposure. We develop a flexible but tractable model economy with commodity exports and imports, in which international financial conditions may vary with the commodity cycle, and we compute the welfare-optimal policy in the presence of price and wage rigidities. Stabilising domestic prices is welfare-optimal for commodity exporters, in line with standard open-economy policy prescriptions. But for economies that use commodities as inputs in production, optimal policy largely ‘looks through’ the direct and indirect effects of commodity shocks on domestic prices; this contrasts with some earlier findings and policy practice (which only ‘looks through’ the direct effect). In emerging and developing economies, where financial conditions are more tied to the commodity cycle, trade-offs are starker and implementing the optimal policy may be challenging, since it requires enough credibility to keep inflation expectations anchored amidst greater volatility in some nominal variables. |
| Keywords: | Monetary policy;exchange rates;inflation targeting;commodity prices;small open economy |
| JEL: | E31 E52 E58 F41 Q02 Q30 |
| Date: | 2026–06–05 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023308 |