Dynamic General Equilibrium Model Research Articles

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.

Market-oriented reforms and wealth inequality in China

Over the last few decades, China’s growing wealth inequality has mirrored the contemporary global trend. We investigate the effects of China’s market-oriented reforms on wealth inequality using a dynamic general equilibrium model with an incomplete market and idiosyncratic risks. Focusing on the relaxation of private entry and the easing of financial constraints as two pivotal reforms, we show that our model-generated results closely match the actual wealth distribution from 1995 to 2018, with the reform of private enterprise entry accounting for most of the widening wealth disparity. We elucidate the underlying mechanisms of these two reforms using counterfactual simulations and discover that through the savings rate mechanism, the two reforms will collectively form an inverted U-shaped Kuznets curve in wealth inequality as reforms deepen in the future. By calculating the transition dynamics from 1995 to 2035, we confirm that the Kuznets turning point in China lies between 2020 and 2025.

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.

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.

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).

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.

Impacts on Regional Growth and “Resource Curse” of China’s Energy Consumption “Dual Control” Policy

Accurately evaluating the effectiveness of the energy consumption “dual control” policy can effectively solve serious the current environmental pollution and promote ecological civilization. However, researchers have rarely considered the impacts on the regional “resource curse” of the energy consumption “dual control” policy. A dynamic computable general equilibrium model (CGE) was built to evaluate the impacts on the regional “resource curse” of the energy intensity control and total energy control policy. The results showed the following. (1) The energy consumption “dual control” policy changes the supply-and-demand relationship of factors and reduces the crowding-out effect of humans and capital. (2) The energy consumption “dual control” policy has restrained GDP growth, and the total output and total investment have declined. However, the impact in regions without the “resource curse” is remarkable. (3) The energy consumption “dual control” policy has a significant inhibitory effect on major pollutants and carbon emissions. (4) The energy consumption “dual control” policy has played a positive role in breaking the regional “resource curse”. The areas with a high and low “resource curse” have become smaller, and the areas without the “resource curse” have increased significantly. The following suggestions are made: (1) increase the flexibility of the “dual control” policy of energy consumption, (2) establish an energy consumption budget management system, and (3) accelerate the establishment of a carbon footprint management system.

Evaluating the macroeconomic impact of environmental policies in New Zealand: A New Keynesian DSGE model to sustainability

This study enhances the environmental New Keynesian framework by integrating spatial spillover effects through a dynamic stochastic general equilibrium model. The simulation results reveal that while environmental regulations can lead to welfare losses, a carbon tax levy mitigates these losses more effectively than alternative approaches in New Zealand. What is surprising is the pro-cyclical nature of environmental policies. For spillovers, shocks to capital and labor tax rates substantially curtail emissions in adjacent regions. Further simulation substantiates that higher price dispersion necessitates a reduced growth rate of emissions. These conclusions compel New Zealand to explore diverse policy options for effectively decarbonizing the economy.

Climate policy and China's external balances

To explore the impact of the China Carbon Emissions Trading Exchange (CCETE) on international trade and capital flow, we develop a two-country dynamic general equilibrium model with asymmetric climate policies. We use targets of decreasing carbon emissions intensity to simulate the strengthening of the CCETE policy. We find that the strengthening of climate policy improves China's trade balance and current account. We also find that output and carbon emissions of the rest of the world with a less stringent climate policy increase (known as carbon leakage) in the short run, but decrease (known as positive externalities of climate policy) in the long run. These findings suggest that China could benefit from more stringent climate policy due to the improvement of its external balances, and the world could also benefit due to the mitigation of climate change.

Aggregated economic damages and the role of dynamic carbon tax under climate change: A dynamic general equilibrium model

A rational assessment of the aggregated economic damages and a more effective carbon tax are crucial for climate governance. However, existing studies still under-recognize the utility damages and dynamic carbon taxes. In this study, we construct a multi-regional dynamic general equilibrium model considering both production and utility damages. Then, this paper re-estimates the regional aggregated economic damages reasonably (including utility damages) and compares in detail the role of static carbon tax, dynamic carbon tax and regionally optimal dynamic carbon tax (RCT). We found that: (1) As climate change intensifies, the world will suffer >8 % of production damage and 1 % of utility damage by the end of the 21st century. Of these, the US and China face more pronounced economic damage. (2) If the carbon tax is implemented only in some regions, other regions will have a “free rider” benefit. An environmentally friendly dynamic carbon tax (fast and then slow) would be more effective, giving economies room to adapt to the carbon tax. The risk of exacerbating global inequality needs to be guarded against when using carbon tax. (3) Based on the regional social cost of carbon (R-SCC), implementing RCT is most effective for curbing climate change and achieving warming targets. This paper contributes to improving the understanding of assessing regional economic damage from climate change and recognizing the role of dynamic carbon tax.

Economy-wide impact of targeting and repurposing fossil fuel subsidies in Malaysia

Fossil fuel subsidy reform is a critical strategy for fostering cleaner energy systems and promoting sustainable development. The Malaysian government has signalled commitments to implement a targeted fuel subsidy reform where vulnerable households would be unaffected by the direct impact of higher fuel prices even after the reform. But despite this commitment, little is known about the economy-wide impact of the reform. This study employs a dynamic Computable General Equilibrium (CGE) model to examine the economic, social, and environmental impact of a targeted fuel subsidy removal in Malaysia under a spontaneous and gradual implementation scenario. The research also explores the impact of direct cash transfers to households and reinvestment in key sectors of the economy in the aftermath of the reform. Results from the study show that subsidy removal brings positive gains to the Malaysian economy in the medium to long term. Sequencing the phaseout of subsidies, providing compensation to vulnerable households, and reinvesting in education, health, transportation, and food assistance helps to avoid short-term adverse effects on households and output. The study recommends the need for a gradual removal of fuel subsidies that is accompanied by cash transfers to vulnerable households and investment in key sectors of the economy.