A rational expectations model for simulation and policy evaluation of the Spanish economy

Abstract

This paper presents the model used for simulation purposes within the Spanish Ministry of Economic Affairs and Finance. REMS (a Rational Expectations Model for the Spanish economy) is a small open economy dynamic general equilibrium model in the vein of the New-Neoclassical-Keynesian synthesis models, with a strongly micro-founded system of equations. In the long run REMS behaves in accordance with the neoclassical growth model. In the short run, it incorporates nominal, real and financial frictions. Real frictions include adjustment costs in consumption (via habits in consumption and rule-of-thumb households) and investment into physical capital. Due to financial frictions, there is no perfect arbitrage between different types of assets. The model also allows for slow adjustment in wages and price rigidities, which are specified through a Calvo-type Phillips curve. All these modelling choices are fairly in line with other existing models for the Spanish economy. One valuable contribution of REMS to the renewed vintage of D(S)GE models attempting to feature the Spanish economy is the specification of the labour market according to the search paradigm, which is best suited to assess the impact of welfare policies on both the intensive and extensive margins of employment. The model’s most valuable asset is the rigour of the analysis of the transmission channels linking policy action with economic outcomes.