Closed Economy Model Research Articles

Inequality, openness, and growth through creative destruction

We examine how inequality and openness interact in shaping the long-run growth prospects of developing countries. To this end, we develop a Schumpeterian growth model with heterogeneous households and non-homothetic preferences for quality. We show that inequality affects growth very differently in an open economy as opposed to a closed economy: If the economy is close to the technological frontier, the positive demand effect of inequality on growth found in closed-economy models may be amplified by international competition. In countries with a larger distance to the technology frontier, however, rich households satisfy their demand for high quality via importing, and the effect of inequality on growth is smaller than in a closed economy and may even be negative. In such case trade gives rise to the endogenous emergence of a ‘dual economy’ where some domestic sectors are highly innovative while others are lagging behind.

Heterogeneous effects of carbon tax, subsidy and foreign carbon emissions on low- and high-carbon firms

Climate change engendered by carbon emissions has become a major threat to human life and the world economy. Many of early studies corroborate that carbon tax and subsidy are effective policy tools to alleviate climate change. Most of them, however, use closed-economy models with a single firm to analyze the effects of these two policies. This paper explores the effects of carbon tax, subsidy and foreign carbon emissions on economic activities in an open macroeconomic model that features low- and high-carbon firms. The main findings suggest that carbon tax, subsidy and foreign carbon emissions all deliver heterogeneous outcomes by largely affecting high-carbon firms. The shortage of national income due to weak economic activities leads the economy to issue more international bonds. The takeaway from all the analyses is that government should introduce various carbon taxes that are geared towards target firms with different carbon emissions and adopt optimal means to manage national debt.

Components of Autonomous Demand Growth and Financial Feedbacks: Implications for Growth Drivers and Growth Regime Analysis

ABSTRACT This paper presents a simple closed-economy model that is driven by the growth of two autonomous components of demand, namely government spending and rentiers’ consumption out of interest income. Using this model, it seeks to make two contributions. First, by focusing on the financial dynamics that arise from debt-financed government spending, we show that an underlying stock-flow interaction provides an endogenous mechanism which, under certain conditions, aligns the two autonomous growth rates in the long run. Hence, an economy can be driven by two autonomous components of demand, without one dominating the other in the long-run nor without policy changes being required to align the two growth drivers. Second, we prove that if two autonomous demand components are dynamically interdependent, then the relative size of their growth contributions may be misleading as a guide to classify growth regimes, both in the long-run equilibrium as well as during the traverse towards this equilibrium. Furthermore, we show that the relative growth contributions are economic policy contingent. We thus argue that interdependencies between autonomous growth components arising from financial stock-flow interactions should not be ignored in Sraffian supermultiplier growth decomposition exercises that aim to identify underlying growth drivers.

Optimal monetary policy in developing countries: The role of informality

In this paper, I analyze optimal monetary policy in developing countries whose labor markets are characterized by the presence of a large informal sector. I develop a closed economy model with nominal price and wage rigidities, search and matching frictions, and a dual labor market: a formal one characterized by matching frictions and nominal wage rigidities, and an informal one where wages are fully flexible. Under this framework, a trade-off between price and wage inflation emerges. I find that informality increases the response of price and wage inflation to aggregate productivity shocks. As a result, the presence of an informal sector increases the inefficient fluctuations of labor market variables, such as unemployment, labor market tightness, and formal hiring rate. I find that optimal policy with informality features significant deviations from price stability in response to aggregate productivity shocks.

Identification Robust Empirical Evidence on the Open Economy IS‐Curve

AbstractExisting empirical evidence on the Euler equation based on closed economy models suggests low responsiveness of aggregate consumption to changes in interest rates. We incorporate open economy features and consider extensions that include habit formation and hand‐to‐mouth consumers. For several open economies and applying econometric methods that are robust to weak instruments and structural changes, we continue to find low values for the elasticity of intertemporal substitution, implying a small effect of real interest rate changes on aggregate income. In some countries, structural changes are informative for identification, but otherwise aggregate data provide limited information to learn about IS‐curve specifications.

Optimal long-run inflation rate in an open economy

I analyze the long-run optimal inflation rate in the sticky price model with trend inflation and a two-country, two-good Ricardian trade structure. As in the closed-economy model, price stickiness effectively reduces an industry’s productivity under trend inflation. Contrary to the standard closed-economy models in which the optimal inflation rate is approximately zero, the model implies that the optimal rate is positive under certain conditions. Welfare gains come from manipulations of the terms of trade, and are hence associated with the loss of the trade partner. If the partner counter-acts, the allocation can be worse than what would occur under autarky.

The Shock Reactions in the Closed Digital Economy

Economic variability can affect economic agents’ risk perception and behavior, which in turn affects negatively economic activities and prosperity. The government, therefore, tries to raise their confidence by designing proper policies to stabilize the economy. To learn the effects of the policies, several models are utilized, and the Dynamic Stochastic General Equilibrium (DSGE) model is recognized as a potential choice for discovering such effects. Also, this work applies the DSGE model to extend its application and contributes to this research area in terms of model construction technique by learning the policy effects in the Thai context through the closed economy models. In this study, Thailand's quarterly detrended data from 2001:Q1 to 2019:Q2 and the Bayesian estimation method were used. The results showed that the positive effect of technological evolution on economic growth occurred in both economies, but the effect in the two-sector economy was less than what occurred in the one-sector economy. Additionally, it was demonstrated that monetary policy was more effective than fiscal policy. Hence, the recommendations were that policy designers had to design policies to improve technology in all sectors simultaneously, and the fiscal authority had to recognize the effect of the number of related agents on the effectiveness of its policies. Also, the monetary authority had to design a boundary for interest rate volatility to stabilize the economy.

Economic Effects of Pension Reform based on Consumption Tax

This paper analyzes the micro and macroeconomic effects of pension reform by a consumption tax hike by using an overlapping-generations model that is primarily based on Groezen, Leers and Mejidam (2003). Although Groezen, Leers and Mejidam (2003) consider pay-as-you-go pension in a model of a small open economy, they do not analyze physical capital accumulation, assume that public pension is financed only by the intergenerational transfer of national pension premiums, and ignore consumption tax as a public pension resource. This study considers pay-as-you-go pension in a closed economy model and assumes that public pensions are financed by both consumption taxes and national pension premiums. In addition, although Groezen, Leers and Mejidam (2003) consider a model with endogenous fertility, this analysis uses a model with exogenous fertility based on Verbon (1988) and Breyer (1989). Subsequently, we consider the micro and macroeconomic effects of the policy that increases the consumption tax rate compared to the effects of increases under a national pension system. We find that even if the population growth rate is negative, both a consumption tax hike and increases in people’s national pension premiums surprisingly promote physical capital accumulation, and if promoting physical capital is enough, such policies enhance economic growth remarkably. Furthermore, we show that a consumption tax hike may promote physical capital accumulation compared to an increase in national pension premiums if the consumption tax rate is not too high.

GDP Modelling and Forecasting Using ARIMA. An Empirical Assessment for Innovative Economy Formation

This article reconsiders the developing of a new forecast model using the interrupted timeseries of the gross domestic product for the Republic of Moldova. The theme arises from a first need to redefine, economic growth in the context of increasing globalization but also the complexity of commercial transactions. The forecasting method used is based on ARIMA each model partly emphasizing the urgent need to redefine, the economic growth in the context of the Association Agreement (AA) with the EU, which includes a Comprehensive Free Trade Agreement (2014) but also future prospects of integration among the countries with an average degree of development. The technique used comes to bring novelty in the field of forecasting, as an alternative to the one which should be —, a simultaneous equations method and traditional VAR. The policy and practical implications of the results are the strengths. The limits are due to the high degree of risk and uncertainty, which is due to the low degree of real convergence of the economy, but also to other factors such as the regional context, the lack of openness of the economy, the diversification of exports and services. The degree of complexity arises from the adaptation and study of the chronological interrupted series 1967−2019 for the branch – information and communications, subgroup GDP, categories of resources, which themselves have specific asymmetries and nuances. The basic ARIMA equations are generally used in conjunction with three sets of assumptions regarding the formation of the gross domestic product, referring to the elasticity of aggregate demand or excess sensitivity supply in the goods and labour markets. Another hypothesis concerns the rigid wage and sticky prices, including deflation with an positive output gap only in the telecom market. Also, the salary is rigid, while the price level is adjusted based on the market of goods and commodities, so that the excess supply appears only in the labour market. Finally, in a third assumption, both markets are assumed to be mutually adjusted. The multipliers of fiscal and monetary policy, besides the conclusions that can be drawn about economic policy, are obviously different in these three assumptions. The article presents a synthetic model that supports the three particular sub-regimes of assumptions of a single adapted ARIMA model, namely the trajectory of New Keynesian Small and Closed Economy Model – a balance in the goods and services, the labour market and the national financial system. In conclusion, the model aims not only to redefine the area of macroeconomic forecasting but also to offer a future perspective of adopting combined techniques such as the Stochastic Dynamic General Equilibrium (K-SDGE) Model with sticky prices and wages – technique, but also the scenario method. This framework is appealing because it has straight forward model setup, transparent mechanisms, sharp empirical analysis, and multiple important applications such as rational expectations.

Gender Issues in Kaleckian Distribution and Growth Models: On the Macroeconomics of the Gender Wage Gap

ABSTRACT We introduce a gender wage gap into basic one-good textbook versions of the neo-Kaleckian distribution and growth model for a developed capitalist economy and examine the effects of improving gender wage equality on income distribution, aggregate demand, capital accumulation and productivity growth. For the closed economy model, reducing the gender wage gap has no effect on the profit share, and a gender equality-led regime requires the propensity to save out of female wages to fall short of the propensity to save out of male wages. For the open economy model, this condition is modified by the effects of improved gender wage equality on exports, and – through changes of the profit share – on domestic demand. Finally, for the open economy with productivity growth we find an unambiguously expansionary effect of narrowing the gender wage gap on long-run equilibrium capital accumulation and productivity growth if the demand growth regime is gender equality-led. A gender equality-burdened demand growth regime, however, may generate different long-run effects of improving gender wage equality on capital accumulation and productivity growth: expansionary, intermediate or contractionary.

Gdp Modelling and Forecasting Using Arima. An Empirical Assessment for Innovative Economy Formation

This article reconsiders the developing of a new forecast model using the interrupted timeseries of the gross domestic product for the Republic of Moldova. The theme arises from a first need to redefine, economic growth in the context of increasing globalization but also the complexity of commercial transactions. The forecasting method used is based on ARIMA each model partly emphasizing the urgent need to redefine, the economic growth in the context of the Association Agreement (AA) with the EU, which includes a Comprehensive Free Trade Agreement (2014) but also future prospects of integration among the countries with an average degree of development. The technique used comes to bring novelty in the field of forecasting, as an alternative to the one which should be —, a simultaneous equations method and traditional VAR. The policy and practical implications of the results are the strengths. The limits are due to the high degree of risk and uncertainty, which is due to the low degree of real convergence of the economy, but also to other factors such as the regional context, the lack of openness of the economy, the diversification of exports and services. The degree of complexity arises from the adaptation and study of the chronological interrupted series 1967−2019 for the branch – information and communications, subgroup GDP, categories of resources, which themselves have specific asymmetries and nuances. The basic ARIMA equations are generally used in conjunction with three sets of assumptions regarding the formation of the gross domestic product, referring to the elasticity of aggregate demand or excess sensitivity supply in the goods and labour markets. Another hypothesis concerns the rigid wage and sticky prices, including deflation with an positive output gap only in the telecom market. Also, the salary is rigid, while the price level is adjusted based on the market of goods and commodities, so that the excess supply appears only in the labour market. Finally, in a third assumption, both markets are assumed to be mutually adjusted. The multipliers of fiscal and monetary policy, besides the conclusions that can be drawn about economic policy, are obviously different in these three assumptions. The article presents a synthetic model that supports the three particular sub-regimes of assumptions of a single adapted ARIMA model, namely the trajectory of New Keynesian Small and Closed Economy Model – a balance in the goods and services, the labour market and the national financial system. In conclusion, the model aims not only to redefine the area of macroeconomic forecasting but also to offer a future perspective of adopting combined techniques such as the Stochastic Dynamic General Equilibrium (K-SDGE) Model with sticky prices and wages – technique, but also the scenario method. This framework is appealing because it has straight forward model setup, transparent mechanisms, sharp empirical analysis, and multiple important applications such as rational expectations.

Investment Timing Theory – A Single Firm Model

Do managers time their investment decisions depending on the heterogeneity of the external conditions? To this extent, I propose a simple one-firm closed economy model to introduce, what I coin, investment-timing theory. I explain the model using the extreme rainfall conditions of excess and deficit rainfall which generate heterogeneous opportunity windows for a manager who needs to make an investment decision.

Identification Robust Empirical Evidence on the Euler Equation in Open Economies

We investigate the empirical evidence on the Euler equation models using methods that are robust to weak instruments and structural changes for a set of eight countries. We start with the conventional closed economy model and consider extensions that include habits and hand-to-mouth consumers. We then extend the analysis to allow for each country to behave like an open economy. We find that structural changes are informative for the identification of the Euler equation models in some countries. However, in all countries, there is limited responsiveness of output to changes in the interest rate and no evidence of parameter instability, but otherwise aggregate data provide limited information to learn about Euler equation models.

A Simple Model of Competition Policies, Trade, and the Skill Premium

How competition policies interact with international trade has been one of the so-called new issues in the WTO. We develop a simple, general equilibrium model to examine the possible interaction between domestic competition policies and trade. In the model, cartels are allowed in that a certain set of firms collude in decision-making, and efficiency gains from a cartel exist in that the fixed costs are shared within a cartel. Then we first show, in a closed economy model, that entry deregulation that reduces the fixed costs of entry can increase the skill premium by increasing the number of firms and decreasing firm size, while an antitrust policy that reduces the size of cartels can decrease the skill premium by decreasing the number of firms and increasing firm size. We next extend the model to a two-country model. In the case of asymmetric countries, though the effects are not clear, our numerical examples show a possibility that entry deregulation and antitrust policy in one country, respectively, can increase and decrease the skill premia in both countries through trade; however, the domestic skill premium is changed by a greater percentage than the foreign one. Finally, available U.S. data show that our model does appear to be empirically relevant.

Environmental Policy Instrument Choice and International Trade

We develop a dynamic stochastic general equilibrium model to understand how environmental policy instrument choice affects trade. We extend the existing literature by employing an open economy model to evaluate three environmental policy instruments: cap-and-trade, pollution taxes, and an emissions intensity standard in the face of two types of exogenous shocks. We calibrate the model to Canadian data and simulate productivity and import price shocks. We evaluate the evolution of key macroeconomic variables, including the trade balance in response to the shocks under each policy instrument. Our findings for the evolution of output and emissions under a productivity shock are consistent with previous closed economy models. Our open economy framework allows us to find that a cap-and-trade policy dampens the international trade effects of the business cycle relative to an emissions tax or intensity standard. Under an import shock, pollution taxes and intensity targets are as effective as cap-and-trade policies in reducing variance in consumption and employment. The cap-and-trade policy limits the intensity of the import competition shock suggesting that particular policy instrument might serve as a barrier to trade.

A multi-sector multi-region economic growth model of drought and the value of water: A case study in Pakistan

This study integrates ecohydrological vegetation and multi-sector multi-region economic growth models to evaluate the impacts of drought on markets and value the economic value of water. The values of several parameters of the agricultural production function are identified by applying leaf area indices that are simulated by the ecohydrological model, AgriCLVDAS. The three-sector three-region closed-economy model with the agricultural production functions of both irrigable and rainfed farmland as well as the stochastic process of precipitation and availability of river water are formulated to analyze the water rent as well as GDP growth in Pakistan under drought stress. According to the characteristics of the closed-economy model, the crop price is increased during drought periods because of the price hike in water (i.e., an increase in the marginal productivity of water, which is double that in high-water periods in Pakistan). The study further presents a way of investigating water resource management policies by applying comparative dynamics.

Inequality, Openness, and Growth through Creative Destruction

We examine how inequality and openness interact in shaping the long-run growth prospects of developing countries. To this end, we develop a Schumpeterian growth model with heterogeneous households and non-homothetic preferences for quality. We show that inequality affects growth very differently in an open economy as opposed to a closed economy: If the economy is close to the technological frontier, the positive demand effect of inequality on growth found in closed-economy models may be amplified by international competition. In countries with a larger distance to the technology frontier, however, rich households satisfy their demand for high quality via importing, and the effect of inequality on growth is smaller than in a closed economy and may even be negative. We show that this theoretical prediction holds up in the data, both when considering growth in export quality at the industry level and when considering growth in GDP per capita.

IS PUBLIC-PRIVATE PARTNERSHIP AN OPTIMAL MODE OF PROVISION OF INFRASTRUCTURE?

The present paper considers a closed economy model with infrastructure service which is an excludable, impure public good, e.g. metro railway service, electricity service, and telephone service etc. The physical capital required by infrastructure sector is provided by public-private partnership. Public and private investment may be complementary or substitute to each other in infrastructure production. We assume government runs a balanced budget. We find there exists unique, saddle path stable growth rate in both the cases. We find that PPP model is optimal in the provision of infrastructure no matter public capital and private capital are a substitute or complementary to each other. But, PPP solution is not growth maximizing in case of substitute relationship between the public capital and private capital. It also makes a comparative study of decentralized economy and command economy. We find that in case of substitute relationship between private capital and public capital, command economy growth rate is higher than the competitive economy growth rate but in the case of complementary relationship between two, command economy growth rate may not be higher than the competitive economy growth rate.

Open-Economy National Income Accounting and the IS/LM Model

When we introduce macroeconomic models, we assume that goods and services are exchanged within a single country but not across countries. This assumption is useful for understanding some of the primary determinants of output, inflation, and interest rates. In reality, however, economies trade with each other, and the presence of international markets has implications for national economies. In this note, we incorporate international markets to understand how changes in one country can affect other countries. Excerpt UVA-GEM-0128 Rev. Dec. 3, 2018 Open-Economy National Income Accounting and the IS/LM Model When we introduced macroeconomic models, we assumed that goods and services were exchanged within a single country but not across countries (i.e., net exports were assumed to be zero). This assumption is useful for understanding some of the primary determinants of output, inflation, and interest rates. In reality, however, economies trade with each other, and the presence of international markets has implications for national economies. This shows up most directly in the open-economy National Income Accounting Identity (Equation 1): where net exports (NX) are exports minus imports, or net sales of goods and services to foreigners. With more exports to other countries and fewer imports, GDP increases. In this note, we incorporate international markets to understand how changes in one country can affect other countries. Relative to closed-economy models, we expand the notion of GDP to account for net exports. But net exports depend on the exchange rate, which depends on international capital flows, which in turn depend on the interest rate, so adding net exports requires a somewhat more complicated model, the Three-Paned Model. . . .

Ramsey-optimal tax reforms and real exchange rate dynamics

We solve the Ramsey-optimal tax plan for a small open economy with an endogenously-determined real exchange rate. The open economy constrains the government's setting of the capital income tax rate since physical capital cannot be dominated in rate of return by foreign assets. However, the endogenous real exchange rate loosens this constraint relative to a one good open economy model in which the real exchange rate is necessarily fixed. We find that the dynamics of the two good small open economy model more closely resemble those of a closed economy model than a one good small open economy model.