Dynamic General Equilibrium Model Research Articles

Sectoral inflation under fragmentation of information

Abstract We examine the role of fragmentation of information in explaining the dynamics of sectoral inflation. Using the quarterly survey of firms’ prices and costs in Japan, we first document two empirical facts: the sensitivity of sectoral inflation to changes in sectoral costs monotonically decreases with the dispersion of changes in (i) current costs and (ii) those in the past. A direct application of the dispersed information model can reconcile the fact (i) but fails to reconcile the fact (ii). We then extend the standard imperfect information model to construct a dynamic general equilibrium model that features fragmentation of information, wherein a finite number of groups of firms exist and firms in the same group share common idiosyncratic noises in their signals. Using this model, we find that the degree of fragmentation of information plays a crucial role in explaining these empirical facts.

Carbon Tax Policy, Stranded Assets and "Double Pillar" Regulation

The risk of a transition from climate policy has drawn widespread attention from central banks. By constructing a new Keynes dynamic stochastic general equilibrium model (NK-DSGE) including climate policy, asset quality and "two-pillar" policy, this paper studies the possible transition risk caused by carbon tax policy and analyzes the transition risk from the perspective of stranded assets. On this basis, the effect of the "dual-pillar" policy to deal with the transformation risk is further evaluated and the optimal policy combination is found through the comparative analysis of social welfare. Research shows that:(1)carbon tax policy has a significant emission reduction effect, but it may cause "stagflation" and lead to the "grounding" of carbon-intensive assets, causing a certain risk of transformation.(2)When the central bank deals with the risk of transformation, it should not only focus on the inflation target. At the same time, we should actively stimulate output, promote the development of the low-carbon sector, solve the mismatch between energy supply and demand, and address the root cause of inflation. When the central bank operates the price monetary policy, the central bank can reduce the risk of transformation and improve the operation efficiency through interest rate smoothing.(3)The macro-prudential policy of "brown punishment" can effectively alleviate the risk of transformation and improve social welfare. The macro-prudential policy of "green support" will not only promote the economic recovery, but also lead to the rising leverage ratio of banks in the short term, aggravating the financial risks faced by banks and causing the loss of social welfare.(4)An effective "two-pillar" policy mix is better to the single use of monetary policy tools in mitigating transition risks and improving social welfare.

Weather Shocks in The Gambia: Macroeconomic Effects and Households Vulnerability

Abstract Climate change is increasing the frequency of weather shocks, which poses a significant challenge for agriculture-dependent economies such as those of sub-Saharan African countries. In this study, we present an innovative framework that combines empirical and theoretical procedures to investigate the propagation mechanism of weather shocks in The Gambia. We first document the propagation mechanism of a weather shock using a Structural Vector Auto-regressive (SVAR) model on the Gambia data. We construct and estimate a Dynamic Stochastic General Equilibrium (DSGE) model to elucidate this mechanism. This model is enhanced to encapsulate the weather-dependent agricultural sector, the heterogeneity of households in terms of access to financial markets and the inflow of remittances. Our findings reveal that weather shocks in The Gambia (i) account for approximately 10% of GDP and agricultural output in the short run, (ii) significantly contribute to long-term consumption volatility,(iii) critically increase the volatility of Ricardian households’ consumption and (iv) stimulate an increase in the direct inflow of remittances to vulnerable households.

Impacts of Re-export Demand on Benin’s Economy

This article analyses the impact of re-export demand on the Beninese economy. Re-export is dominant in Benin’s trade and may represent risks to the economy’s vulnerability. The methodology uses a dynamic computable general equilibrium model. It simulates two scenarios: the first considers a one-off decline in re-export demand in the first year, while the second analyses the impact of a recurring annual shock. The results, both at the aggregate and sectoral levels, indicate that the decline in re-export demand would negatively affect real GDP, domestic and net external demand, and most industries. This article extends the existing knowledge on the re-export phenomenon by adding a dynamic analysis of its potential impact at the aggregate and sectoral levels. The results confirm that re-export is a source of vulnerability for the Beninese economy. The authorities should focus on diversifying the economy and strengthening the competitiveness of the Port of Cotonou, in order to mitigate vulnerabilities linked to re-export activities. JEL Codes: C68, F17

Optimal Trade Policy in a Ricardian Model with Labor-Market Search-and-Matching Frictions

Abstract I develop a dynamic general-equilibrium model that combines the Diamond–Mortensen–Pissarides labor market with the standard Ricardian model of international trade to investigate the potential role of unemployment as a justification for trade policy implementation. First, I compare a competitive equilibrium and a constrained-efficient equilibrium and then establish the condition in which the competitive equilibrium is constrained-efficient. Second, I show that free trade is optimal only when labor market inefficiency is absent. A small open economy may employ expansionary trade policies (such as export subsidies or reduced import tariffs) if it experiences inefficiently high unemployment. This study provides a rationale behind countries’ tendency to use export subsidies.

Optimum low-carbon transformation pathways of China’s iron and steel industry towards carbon neutrality based on a dynamic CGE model

Low-carbon transformation pathways of the iron and steel industry play a significant role towards achieving the carbon neutrality target by 2060. This study explores the low-carbon transformation pathways of China’s iron and steel industry in 2060 under different emission reduction policy scenarios by adopting a modified dynamic computable general equilibrium model. We found that: (1) China’s crude steel production will peak in 2024–2026, with a value of approximately 10.49 × 102–11.11 × 102 Mt. (2) Four integrated policy scenarios (C1T1E2: carbon trading policy, carbon tax, and renewable energy policy; C1T6E2; C6T1E2; and C6T6E2) have the most potential to achieve the carbon neutrality target by 2060; their remaining CO2 emissions are 2.52 × 102, 1.99 × 102, 1.21 × 102 and 0.69 × 102 in 2060, respectively. (3) The projected CO2 emissions per ton steel from 2020 to 2060, of which the impact degree in the carbon trading market policy scenario shows the most difference, fluctuated from 0.81 t CO2/t under the C1 scenario to 0.42 t CO2/t under the C6 scenario in 2060. (4) The reduction degree of energy consumption per ton steel performed the best in the integrated policy scenarios, of which the integrated C6T6E2 scenario (82 kgce/t in 2060) had the most effect on energy consumption per ton steel, followed by C6T1E2 (101 kgce/t) and C1T6E2 (125 kgce/t).

Does cross‐fertilization occur in recent macroeconomics? A quantitative exploration of the interactions between DSGE and MAB models

AbstractThe dominant approach to macroeconomics has always claimed its capacity to incorporate new ideas, continuously adapting its models in order to address contemporaneous challenges. This narrative leads to present academic macroeconomics research as driven by a continuous linear progress. 2008 and its trail of crises seems to have revealed more openly that such interactions, to consider that they may have existed, may no longer operate. Focusing on recent period, we propose to challenge this narrative, investigating whether such interactions still exist today and questioning their nature. We established a set of 2299 articles composed by Dynamic Stochastic General Equilibrium (DSGE) models and Macro Agent‐Based Models (MABM). We investigate the structure of the social communities authoring these articles and their intellectual interactions in view of establishing their relative fragmentation or strong scientific unity. Bibliographic coupling reveals that DSGE and MABM literatures refer to two different sets of bibliographic references. We also pay attention to two communities known to be interstitial: HANKs and hybrid models. While the overall results exhibit a relative fragmentation of these communities, they do not provide evidence of collaboration between MABM and DSGE authors. Rather, results suggest a completely dissymmetric influence from DSGE on the MABM literature

Modeling Inflation Expectations in Forward-Looking Interest Rate and Money Growth Rules

We propose a novel approach that directly embeds rational expectations (RE) into a low-dimensional structural vector autoregression (SVAR) without the need for any mapping to a dynamic stochastic general equilibrium (DSGE) model. Beginning from a fully specified “consensus” structural model, we establish an instrumental variable procedure internal to the SVAR to obtain RE-consistent structural responses to identified monetary policy shocks. Our RE-SVAR framework facilitates a comparison across two alternative monetary policy indicators that accommodate long horizons in the formation of inflation expectations in the policy rule. We construct clouds of responses of inflation and economic activity to monetary policy shocks. We find large regions of puzzling responses to innovations in the federal funds rate. This suggests that indicator often requires being augmented with more information in standard VAR settings. A money growth rule characterization—with Divisia M4 as a policy indicator—exhibits comparatively larger regions of sensible responses within a low-dimensional textbook model of the economy.

Monetary policy stabilization in a new Keynesian model under climate change

We address the question of whether monetary policy is affected by the detrimental impact of climate change on an economy's productivity and, if so, whether policymakers should take it into account when designing policies to stabilize the business cycle. To do this, we develop a new Keynesian dynamic stochastic general equilibrium model of a closed economy which incorporates a climate module that interacts with the economy. In this framework, monetary authorities choose the nominal interest rate on government bonds. The model is solved numerically using parameter values calibrated to the US economy. Our results, which are robust to both extensions and a large number of sensitivity checks, suggest non-trivial implications for the design of optimal monetary policy irrespectively of whether the shocks hitting the economy are standard economic shocks, climate shocks, or shocks to the price of energy.

The impact of carbon capture, utilization, and storage (CCUS) projects on environmental protection, economic development, and social equity

We present a Dynamic Computable General Equilibrium (DCGE) model to estimate the long-term impacts of CCUS on carbon emission reduction, energy structure, economic growth, and social welfare. Results show that CCUS contributes to optimizing energy structure led by renewable sources and raises the share of clean energy generation to 85.41%–89.84% in 2060. CCUS can help China achieve an earlier peak in carbon emissions and subsequent reductions, with the emission reduction contribution of CCUS estimated at 27.41%–65.00% of total emissions by 2060. Our findings suggest that CCUS has the potential to support China's sustained economic growth, with real GDP rising by 8.82%–18.16% in 2060 compared to the baseline scenario. Additionally, the CCUS fosters growth in social welfare and contributes to mitigating the urban-rural income disparity in the long term. The study broadens the scope of the economic assessment of CCUS and provides valuable insights to enhance comprehension of CCUS's strategic positioning and implementation.

Comparative analysis of carbon emission reduction policies in China's manufacturing and transportation sectors

This study evaluates China's environmental policies, specifically the increase of carbon emission tax rates and the reduction of carbon emission intensity, by developing a New Keynesian Dynamic Stochastic General Equilibrium (NK-DSGE) model that incorporates energy consumption and carbon emissions. The production sector is segmented into manufacturing, non-manufacturing, and transportation, with transportation services acting as inputs for both manufacturing and non-manufacturing firms. We construct four cases within two scenarios, each characterized by distinct targets and policies. After calibrating and estimating the relevant parameters, we compare carbon reduction outcomes and economic fluctuations across the two scenarios. Our findings indicate that when targeting the same carbon emission tax rate increase or carbon emission intensity ratio reduction, policies that increase the carbon emission tax rate or reduce carbon emission intensity implemented in the manufacturing sector achieve greater carbon emission reductions compared to the same polices implemented in the transportation sector. Meanwhile, compared to the latter case, output experienced a greater decline, and inflation exhibited a more substantial increase in the former case. However, when the quantities of carbon emission reductions are approximately the same in the first quarter, policies that increase the carbon emission tax rate or reduce carbon emission intensity enacted in the transportation sector demonstrate superior performance relative to the same polices implemented in the manufacturing sector. This leads to smaller final output reductions and milder inflation increases. In summary, for equivalent levels of carbon emission reductions, policies implemented in the transportation sector yield more favorable economic outcomes than those applied in the manufacturing sector.

A DYNAMIC ANALYSIS OF THE IMPACTS OF A CONSUMPTION TAX INCREASE AND A PRODUCTIVITY SHOCK: CALIBRATED FOR THE BRAZILIAN ECONOMY

Objective: Analyze the effects of high consumption tax on key macroeconomic variables. Method: The analysis employs both a Dynamic General Equilibrium (DGE) model and a Dynamic Stochastic General Equilibrium (DSGE) model, calibrated to the Brazilian economy. The models simulate the impact of an increase in the consumption tax on key macroeconomic variables and the impact of a productivity shock in an economy with and without taxation, respectively. Results and Discussion: The results show that an increase in the consumption tax leads to a gradual decline in the capital stock and a sharp reduction in labor supply. Furthermore, productivity shocks have weaker positive effects on investment, output, consumption, and the capital stock in an economy with high taxation compared to one without it. The discussion emphasizes the importance of these findings in understanding the trade-offs between taxation and economic activity. Research Implications/Value: The findings suggest that effective allocation of tax revenues—such as investments in infrastructure, education, and technology—is essential to mitigate the negative impacts of consumption taxes on economic performance and foster long-term productivity and growth.

Employment Shift in Response to a Technology Shock: An Analysis of Two Rigidities and Two Agents

This paper examines the relationship between a technology shock and employment, considering price, wage rigidities, and heterogeneous agents. To explore this relationship, we utilized a Dynamic Stochastic General Equilibrium (DSGE) model, incorporating households with varying savings rates. For empirical validation, we conducted a Structural Vector Autoregression (SVAR) analysis using data from two economies with distinct savings patterns—the United States and China. This approach allowed us to assess the impact of technology shocks on employment dynamics across different savings environments. Under these conditions, we observe that the effect of technology on aggregate employment is initially positive. Still, it gradually decreases in the mid-term, eventually switching to a negative impact before slowly recovering to equilibrium. The reason for this phenomenon depends on (i) the magnitude of fluctuations in price and wage, precisely, which variable’s fluctuations have a greater magnitude, and (ii) which effect, between income effect and substitute effect, is preferred by restricted and unrestricted households. Due to (i), real wages change, and because of (ii), households make different labor supply decisions, leading to fluctuations in employment in response to technology shocks.

Examining the effectiveness of dissuasive taxes as a policy tool for reducing tobacco and alcohol consumption in Cameroon: A welfare and microsimulation analysis

Deterrent taxes are a crucial policy tool for reducing the consumption of harmful products like tobacco and alcohol. However, assessing dissuasive taxes impact different income groups is important to ensure that their burden is not disproportionately borne by low-income households. This study examines the effectiveness of deterrent taxes as an economic policy tool for reducing tobacco and alcohol consumption in Cameroon. We analyse the impact on household welfare and distributional effects using microsimulation analysis. The data come from the Cameroon Household Living Conditions Survey and the 2022 tax records. Our methodology is based on a dynamic computable general equilibrium (CGE) model enriched with an addiction model. The results indicate that deterrent taxes can significantly reduce the consumption of these harmful products but also have regressive effects on low-income households. In response, we recommend the adoption of a progressive tax structure and the establishment of targeted support programmes to mitigate the negative impact on vulnerable populations.

The impact of central bank digital currency on macroeconomic dynamics: A DSGE analysis

This study investigates the impact of Central Bank Digital Currency (CBDC) on macroeconomic fluctuations under various external shocks, expanding the research on macroeconomic effects of CBDC issuance. We develop a dynamic stochastic general equilibrium (DSGE) model to examine the effects of different external shocks on the macroeconomy under three scenarios with varying CBDC rules. Our analysis reveals that, in the presence of CBDC, macroeconomic variables are generally more volatile after exogenous shocks than in the absence of CBDC, while highlighting the crucial role of monetary policy in stabilizing the macroeconomy. Liquidity and substitution effects are identified as main drivers of the results. These findings offer new insights into the welfare improving effect of interest-bearing CBDC, carrying significant implications for the effective implementation of monetary policy.

Parameter instabilities and monetary policy in a small open economy: Evidence from an estimated model for the UK

This paper reconsiders whether monetary policy in small open economies responds to exchange rates by studying possible parameter instabilities in a Dynamic Stochastic General Equilibrium model. The main focus of the paper is to revisit preceding evidence on the response to exchange rate movements by the Bank of England and determine if its reaction function has remained constant throughout the sample. To this end, I estimate a small open economy general equilibrium model using Bayesian econometric techniques over rolling windows. I find overwhelming evidence of shifts in several parameters, including those related to the policy rule. Furthermore, posterior odds tests reveal a time-varying response to exchange-rate fluctuations by the monetary authorities. The results favor the model with the nominal exchange rate embedded in the policy rule for the initial subsamples. However, the evidence steadily evolves across windows and ultimately changes to prefer the model specification with no exchange rate. The paper also documents evident variations in the model dynamics derived from the instability of parameters via rolling-window impulse response functions and variance decomposition analysis.

Optimal environmental policy and business cycles: An analysis using an E2-DSGE model

What are the effects of adopting a comprehensive environmental policy that considers, in addition to taxes on emissions, taxes and subsidies in the energy sector? This paper answers that question using a dynamic stochastic general equilibrium model augmented to include environmental issues and an energy sector featuring non-renewable and renewable energy production. The model is used to find the optimal trajectories of the environmental policy instruments and to analyze the dynamic behavior of the model variables in response to productivity shocks. First, we show that tax and subsidy rates are procyclical. Second, we show that having access to alternative sources of (renewable) energy allows households and firms to replace non-renewable (polluting) energy sources with renewable (cleaner) energy sources in response to productivity shocks. Finally, a welfare analysis of different policy alternatives shows that a broad environmental policy is welfare superior to policies that do not include a full set of taxes and subsidies in the energy sector.

Asymmetric distance and business cycles (ΑDBC): A new understanding of distance in international trade models through the example of Iran's trade corridors

We introduce a new concept of distance, and the way this could affect gravity-based trade modeling. Our motivation is twofold: a) global uncertainty in trade relations allows us to treat distance as an asymmetric shock in economic modeling; b) economies of scale in seaborne trade make geographical distance less relevant in trade models, substituted by economic distance, as this can be proxied by ocean freight rates. This, for instance, allows China to import iron ore from Brazil, at three times the distance compared to Australia. We enhance the New Keynesian Dynamic Stochastic General Equilibrium Model (DSGE) by incorporating a distance shock parameter into the transaction costs function. We test this on Iran's participation in the Shanghai Cooperation Organization as well as in the International North-South Transport Corridor. We conclude that longer physical distances do not necessarily have a negative impact on trade.

Quantitative Easing and Direct Lending in Response to the COVID‐19 Crisis

AbstractThis paper develops a dynamic general equilibrium model to study quantitative easing (QE) and direct lending to firms. QE works through three channels: expanding bank reserves raises liquidity and lowers the liquidity premium, purchasing assets withdraws risk and lowers the volatility risk premium, and the resulting economic stimulus lowers the credit risk premium. When bank reserves are higher, the liquidity premium channel is weaker, and QE is less expansionary. Direct lending is more expansionary than QE because it substitutes bank lending and mitigates the credit risk frictions associated with bank lending, while QE stimulates bank lending and worsens the frictions.

The Labor Market and Growth Implications of Skill Distribution: A Dynamic General Equilibrium Model with Skill Heterogeneity

This paper develops a dynamic general equilibrium model which explicitly incorporates the skill distribution of heterogeneous workers. Workers are distributed heterogeneously in their individual skill level and can be endogenously sorted into different tasks using different technologies. In doing so, we study in depth the labor market and growth implications of the changes in skill distribution. Specifically, we consider two changes in the skill distribution in a given population, (i) the increased density in the upper tail (skill upgrading), and (ii) the increased density both in the lower and upper tails (skill polarization). It is shown that, though the labor market implications for individual workers are likely to be largely different and complex (skill polarization even leads to nonlinear labor market changes), both changes in the skill distribution may increase steady-state real investment and enhance growth so that all workers gain with time.