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on Dynamic General Equilibrium |
| By: | Christophe Cahn; Patrick Fève; Julien Matheron |
| Abstract: | This paper traces how dynamic stochastic general equilibrium (DSGE) models became a central tool for quantitative policy analysis in Central Banks. Their appeal grew out of the shortcomings of large-scale macroeconometric models, the Lucas and Sims critiques, and the gradual shift from real-business-cycle theory to the New Keynesian framework. The paper reviews the medium-scale DSGE model that became standard in policy institutions, as well as extensions dealing with unemployment, open-economy transmission, financial frictions, and fiscal policy. It also discusses the practical machinery (solution, estimation, forecasting, and counterfactual analysis) through which these models are brought to the data and used in policy work. The final part turns to heterogeneous-agent New Keynesian models (HANK), where incomplete markets and distributional heterogeneity reshape the transmission of monetary and fiscal policy. The central claim is that DSGE models remain valuable less as definitive descriptions of the economy than as a disciplined way to connect theory, data, and policy experiments, while identifying where richer mechanisms are needed. |
| Keywords: | DSGE Models; Central Banks; New Neoclassical Synthesis Models; HANK; Monetary Policy; Policy Analysis |
| JEL: | E32 E52 E58 C11 D14 D31 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:bfr:banfra:1066 |
| By: | Juvonen, Petteri; Silvo, Aino |
| Abstract: | We document the current specification of Aino 2, the dynamic stochastic general equilibrium (DSGE) model used at the Bank of Finland for forecasting and policy analysis, originally introduced under the name Aino 2.0 in Kilponen et al. (2016). It is a large-scale estimated New Keynesian small open economy model with an explicit banking sector, designed to capture key features of the Finnish macroeconomy. Since its introduction, the model has been updated to include various features with a view of improving its performance in practical policy work. The most important modifications include the adoption of general constant relative risk aversion preferences, a revised wage-indexation mechanism that generates more realistic wage dynamics in forecasting applications, and fixed production costs that improve the model's ability to match labour market and productivity fluctuations. A companion Technical Appendix provides the derivation of full equilibrium conditions, analytical steady state solution, and log-linearised dynamic equilibrium conditions. |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:zbw:bofrdp:344111 |
| By: | Nabil Daher |
| Abstract: | This paper examines the complex trade-off between inflation stabilization, debt sustainability, and economic recovery resulting from natural disasters in developing economies. I develop a small open economy New Keynesian DSGE model in which disaster shocks destroy productive capital, reduce productivity and generate substantial reconstruction needs and fiscal pressures. The model examines how these shocks are transmitted under monetary and fiscal dominance. Results show that natural disasters increase public debt, weaken fiscal policy's ability to stabilize the economy, and constrain monetary policy. Under monetary dominance, the central bank preserves price stability more effectively, but this requires stronger fiscal adjustments and results in a deeper contraction in economic activity. Under fiscal dominance, monetary policy accommodates the deterioration of public finances: inflation rises, reducing the real value of government liabilities and facilitating fiscal adjustment. Welfare analysis indicates that partial monetary accommodation may be desirable in disaster-prone economies because it reduces output volatility and eases the real value of public debt, albeit at the cost of higher inflation post-disaster. |
| Keywords: | natural disasters; DSGE; policy-mix; fiscal dominance; developing economies |
| JEL: | E32 E52 E61 E62 E63 F41 H63 O23 Q54 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:drm:wpaper:2026-22 |
| By: | Alina Ermolaeva; Hannah Magdalena Seidl |
| Abstract: | Does artificial intelligence (AI) change the transmission of monetary policy? We develop a two-sector heterogeneous-agent New Keynesian model with task-based production, in which AI automates part of the work in one exposed sector and leaves the other shielded. In the AI steady state, the economy holds more capital, and labor income shifts from the exposed workers, who lose through hours, to the shielded workers, who gain through higher wages. We then compare the same rate cut across the two economies. It stimulates macroeconomic aggregates more in the AI economy. The deeper capital stock delivers a larger initial stimulus. Investment responds as strongly as without AI, but on a permanently larger base, so the same response means more demand. Machines absorb part of the exposed sector’s share of that demand. The shielded sector’s share becomes labor income, which is spent in turn. It matters who gets automated: the amplification of monetary policy in an AI economy runs through the workers AI does not replace. |
| Keywords: | Artificial intelligence, automation, task-based production, HANK, monetary transmission, labor share, sectoral incidence |
| JEL: | E21 E24 E32 E52 J23 O33 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:diw:diwwpp:dp2184 |
| By: | Stefano Carattini; Giseong Kim; Givi Melkadze; Aude Pommeret |
| Abstract: | Many emerging economies tend to rely considerably on carbon-intensive sectors, exposing themselves to potential transition risk. This paper quantifies the impact of this risk and the role of various policies and policy designs in mitigating it. It does so with a two-country two-sector environmental dynamic stochastic general equilibrium model, where each “country” represents a bloc of advanced or emerging economies, respectively. The model includes real-world features such as financial frictions and financial and trade linkages across blocs. With it, we simulate climate policy in advanced economies, in the form of carbon taxes and tariffs, and international coordination around a minimum global carbon price. This paper identifies and quantifies important vulnerabilities among emerging economies to the implementation of climate policy in advanced economies. |
| Keywords: | transition risk, emerging economies, financial frictions, environmental dynamic stochastic general equilibrium model |
| JEL: | E44 E58 F38 F42 G18 O11 Q58 |
| Date: | 2026 |
| URL: | https://d.repec.org/n?u=RePEc:ces:ceswps:_13069 |
| By: | Francesco Zanetti; XIWEN BAI; JESÚS FERNÁNDEZ-VILLAVERDE; YILIANG LI; RICARDO MARTO |
| Abstract: | We study the macroeconomic and trade-policy implications of disruptions to U.S.-bound shipping routes. Standard models treat them as iceberg-cost shocks, conflating the shock with the response to it. Using satellite vessel-tracking data, we construct route-level measures of potential and effective capacity for all U.S.-bound container ships from 2016 to 2025. Utilization losses in recent disruptions ran 20 to 40 percentage points, and began months before port congestion became visible. We embed these measures in a general equilibrium model in which firms reallocate a common fleet without internalizing the congestion they create and price above marginal cost, while importers sourcing responds to route profitability. The reallocation triggered by a disruption then has first-order welfare effects, and the routes Domar weight is not a sufficient statistic for its welfare cost. The 2021 West Coast crisis and the 2023–2024 Red Sea attacks cost 0.69% and 0.35% of output. Naval protection of Red Sea shipping generated benefits of 0.04–0.08% of output at a fiscal cost of 0.02%. Tariffs decongest the routes they tax, offsetting or even reversing their conventional welfare cost. |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:cnn:wpaper:26-016e |
| By: | Abad, Jorge; Nuño, Galo; Bigio, Saki; Garcia-Villegas, Salomon; Marbet, Joël |
| Abstract: | How does heterogeneity in banks’ interest-rate risk exposure shape monetary policy transmission? We develop a quantitative macroeconomic model of heterogeneous banks to answer this question. We establish an irrelevance result: differences in interest-rate risk exposure between fixed- and variable-rate banking systems matter for transmission only when bank solvency concerns become relevant. Calibrating the model to the euro area, we show that idiosyncratic default risk pushes a substantial share of banks toward the solvency threshold, making heterogeneity quantitatively important. When policy rates rise, fixed-rate banks suffer net interest margin compression—funding costs increase while legacy loan income stays unchanged—eroding capital and triggering sharper deleveraging. The lending elasticity to monetary policy is one-third larger in fixed-rate economies. The effects extend to financial stability: tightening raises bank failure rates in fixed-rate systems while lowering them in variable-rate systems. The results provide a rationale for macroprudential and monetary policy coordination and for monetary policy gradualism. JEL Classification: E51, E52, G21, G28 |
| Keywords: | bank solvency, capital requirements, interest-rate risk, macroprudential policy |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:ecb:ecbwps:20263299 |
| By: | Stefan Hohberger |
| Abstract: | This paper analyses the structural drivers of bilateral real exchange rate dynamics within the euro area and between the euro area and the United States over 1999-2025, using an estimated seven-country New Keynesian DSGE model of the world economy. The model features an ex ante identical structure across the country blocs and is estimated on a unified information set. International financial market shocks dominate the EA-US bilateral real exchange rate dynamics, with productivity differentials generating persistent euro appreciation pressure. Rising world demand and a secular decline in EA home bias exert partially offsetting euro depreciation pressure. Within the monetary union, the pre-crisis appreciation of France, Italy, and Spain relative to Germany reflects country-specific combinations of demand, supply, and trade disturbances that broadly unwind after 2008. Trend productivity differentials emerge as the dominant low-frequency driver, most starkly for Italy, where persistently slower trend productivity growth drives the bilateral real exchange rate through the sample. Model validation against empirical moments, exchange rate pass-through benchmarks, and off-model indicators confirms the empirical plausibility of the structural identification. |
| Keywords: | real exchange rates, euro area competitiveness, multi-country DSGE, Bayesian estimation |
| JEL: | C51 E32 F41 F45 |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:een:camaaa:2026-85 |
| By: | Henrique S. Basso (Banco de España and CEMFI); Olympia Bover (CEMFI, Centro de Estudios Monetarios y Financieros); Julio Galvez (CUNEF University); Laura Hospido (Banco de España, CEMFI, and IZA) |
| Abstract: | Household consumption and saving depend on perceived income risk, yet macroeconomic models typically discipline income processes using realized data. We show that these objects differ systematically. We develop a framework to recover flexible income processes from subjective expectations reported over fixed intervals, accounting for coarse elicitation and focal responses. Households perceive income as more persistent and less dispersed, with weaker state-dependent nonlinear dynamics than realized histories imply. These differences survive adjustments for reporting, measurement error, and horizon differences. In a life-cycle model, they affect precautionary saving and wealth accumulation; when households save according to perceived dynamics but face realized shocks, consumption insurance falls substantially. |
| Keywords: | Subjective expectations, income dynamics, nonlinear persistence, consumption, precautionary saving, life-cycle, panel data. |
| JEL: | D15 D31 D84 E21 C23 |
| Date: | 2026–09 |
| URL: | https://d.repec.org/n?u=RePEc:cmf:wpaper:wp2026_2614 |
| By: | Arthur Mendes; Wataru Miyamoto; Thuy Lan Nguyen; Steven Pennings |
| Abstract: | This paper studies the local and aggregate effects of cash transfers in developing countries, and how both change as the cash transfer program scales up. We build a two-region New Keynesian small open economy model and calibrate it to rich pre-treatment microdata from an ongoing cash transfer experiment in Malawi. The model implies a local multiplier on temporary transfers of about one, which depends on price stickiness, the share of liquidity-constrained households, and home bias in consumption. Spillovers to the rest of the country are negative under Malawi’s restricted international capital mobility and parallel exchange rate regimes, as cash transfers appreciate the real exchange rate and reduce exports. Consequently, the aggregate multiplier is less than the local multiplier. As the program scales up, the local multiplier converges toward the aggregate multiplier, so a scaled-up program may have smaller multipliers than micro-level estimates suggest. However, with unrestricted capital mobility, spillovers can be positive, especially under a fixed exchange rate. These results highlight the importance of the macroeconomic policy environment for aggregate multipliers and the effects of scaled-up transfer programs. |
| Keywords: | cash transfers; randomized controlled trials (RCTs); local multipliers; developing countries; exchange rate regimes |
| Date: | 2026–10–13 |
| URL: | https://d.repec.org/n?u=RePEc:fip:fedfwp:103935 |
| By: | Marco Carli (Italian Ministry of Economy and Finance and Tor Vergata University); Francesca Diluiso (Bank of England); Mathias Hoffmann (Deutsche Bundesbank) |
| Abstract: | How should monetary policy respond to climate policy shocks? We develop an Environmental New-Keynesian model with green and fossil energy to assess the macroeconomic impacts of carbon pricing and green subsidy shocks and to identify the optimal monetary policy responses. Our findings indicate that these shocks create a policy trade-off between stabilizing inflation and the output gap. This trade-off is resolved in favor of output-gap stabilization, with optimal monetary policy focusing on dampening real output fluctuations while temporarily looking through inflation movements. Dual mandate Taylor rules yield lower welfare costs than inflation-only targeting rules and align the welfare performances of core and headline inflation targeting regimes. |
| Keywords: | Climate policy;E-DSGE models;monetary policy trade-offs;supply shocks. |
| JEL: | E31 E52 Q43 Q58 |
| Date: | 2026–10–09 |
| URL: | https://d.repec.org/n?u=RePEc:boe:boeewp:023787 |
| By: | Mario Alloza (Banco de España); Rubén Domínguez-Díaz (Banco de España); Pau Durá (Universitat de València); Iacopo Varotto (Banco de España) |
| Abstract: | We estimate the macroeconomic effects of defence expenditure using a novel dataset covering the universe of defence procurement contracts in Spain over 30 years. Our defence procurement data overcomes identification challenges posed by implementation lags inherent in traditional government spending, as contracts are awarded years before production begins and spending is recorded in government national accounts only upon delivery. Using local projections, we find that GDP effects take time to materialise, become sizeable, but remain transitory. That is, while defence investment has relevant economic consequences, these are bound to occur in the medium run insofar as the spending process is hindered by implementation lags. A DSGE model calibrated to our empirical setting yields two main findings. First, reducing implementation lags to US levels would meaningfully frontload the macroeconomic effects. Second, defence spending delivers more transient and smaller long-run effects than general public investment projects. |
| Keywords: | defence, fiscal policy, multipliers, local projections |
| JEL: | C32 E32 E62 H56 |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:bde:wpaper:2637e |
| By: | Anastasios G. Karantounias (University of Surrey); Vytautas Valaitis (University of Surrey) |
| Abstract: | This paper studies optimal time-consistent distortionary taxation with default. The government taxes labor income or issues non-contingent debt to finance an exogenous stochastic stream of fiscal shocks. Debt can be repudiated subject to default costs. Optimal policy is characterized by two opposing incentives that capture the double lack of commitment to old tax policies and to repaying debt, respectively: an incentive to postpone taxes by issuing more debt for the future (“Greed†), and an incentive to tax more currently to avoid punishing default premia (“Fear†). A Generalized Euler Equation captures these forces and determines the optimal back-loading or front-loading of tax distortions. Even with small default risk, tax-smoothing and debt issuance are substantially limited when short-term debt is available. The same mechanisms operate in environments with long-term debt, but debt serves more as a fiscal absorber. |
| JEL: | D52 E43 E62 H21 H63 |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:sur:surrec:0626 |
| By: | Badinger, Harald; Glocker, Christian; Schiman-Vukan, Stefan |
| Abstract: | Using a structural VAR with a relatively agnostic identification based on narrative sign restrictions, this paper, in line with recent empirical evidence, documents an increase in the labor share following restrictive monetary policy in the euro area. We then complement the empirical analysis with a theoretical investigation that provides mechanisms linking monetary policy and the labor share—a connection that has so far been regarded as lacking an explanation. Specifically, we show that the observed responses of the labor share, real wages, and productivity to a monetary policy shock can be reconciled within an otherwise standard New Keynesian framework once capital accumulation is introduced and both nominal and real frictions—in particular, labor adjustment costs—are incorporated. |
| Keywords: | Monetary policy; labor share; euro area; structural VAR; New-Keynesian model; labor market frictions |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:wiw:wus005:91592993 |
| By: | Michele Battisti; Giovanni Peri; Eleonora Romano |
| Abstract: | Immigration affects natives through both labor markets and public budgets, yet these channels are usually studied separately. We combine them in a general-equilibrium model with search-and-matching frictions, skill-specific progressive labor taxes, capital taxation and public goods, calibrated to 17 OECD countries over 2015-2019. The welfare effect on natives of a one-percentage-point increase in immigrant inflows varies in sign and size across countries, hinging on immigrants' skill mix, immigrant-native wage gaps, resident unemployment, and tax progressivity. For inflows matching the skill composition of 2019-2024 arrivals, native welfare rises in 14 of 17 economies, and in most cases both skill groups gain, through different channels. Lower-skilled natives gain mainly from higher pre-tax earnings, driven by job creation and complementarity with skilled immigrants; higher-skilled natives gain mainly from lower labor-tax burdens. Evaluating immigration policy thus requires modeling labor-market and fiscal channels jointly: either channel alone gives an incomplete picture of who gains and why. |
| JEL: | E24 F22 H20 J61 |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35901 |
| By: | Alessandro Guerriero; Giuseppe Pagano Giorgianni |
| Abstract: | Perceived inflation in the euro area systematically departs from measured HICP inflation. This gap arises because households place disproportionate weight on salient consumption items, especially frequently purchased goods such as food. Since these items also tend to adjust prices more often, they generate inflation signals that are noisier and more volatile than aggregate inflation. At the micro level, households that are more exposed to food in their consumption basket exhibit a stronger response of perceived inflation to an adverse food supply shock. Additionally, stronger inflation perceptions are accompanied by a sharper increase in pessimism regarding consumption attitudes. At the macro level, perceived inflation reacts with more intensity and persistence compared with actual inflation, while retail sales decline. To interpret these results, we develop a HANK framework with non-homothetic preferences and subjective inflation perceptions. The model shows that heterogeneity in consumption baskets and the greater price volatility of salient goods jointly amplify the effects of negative supply shocks affecting those goods, turning food price disturbances into broader and more persistent contractions in economic activity. |
| Keywords: | Inflation perceptions; HANK; Proxy-SVAR; Local Projections |
| JEL: | E31 D84 E21 E32 C23 |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:sap:wpaper:wp285 |
| By: | Rohan Kekre; Moritz Lenel |
| Abstract: | We propose a general equilibrium model in which U.S. monetary policy affects global risk premia by revaluing the wealth of currency-mismatched arbitrageurs. Assuming their portfolios are mean-variance efficient, arbitrageurs must be short the dollar. A U.S. tightening thus erodes arbitrageurs' net worth and raises the global price of risk. We discipline this mechanism to rationalize the effects of U.S. monetary policy on international asset prices, and we quantify the associated macroeconomic spillovers and role of policy responses abroad. In a potential future with higher dollar interest rates, arbitrageurs' dollar funding and U.S. monetary policy spillovers are dampened. |
| JEL: | E44 E52 F31 G15 |
| Date: | 2026–10 |
| URL: | https://d.repec.org/n?u=RePEc:nbr:nberwo:35902 |