Dynamic General Equilibrium Model Research Articles

Macroeconomic impact of environmental policy uncertainty and monetary policy implications

This paper evaluates the macroeconomic implications of uncertainty arising from delays or unpredictability regarding the timing and extent of environmental policy implementation. An environmental dynamic stochastic general equilibrium (E-DSGE) model shows that increasing uncertainty about environmental policies is associated with a subsequent decline in investment, as firms prefer to postpone investment decisions. The decline in physical investment within polluting sectors subsequently induces a fall in employment, consumption and output. Using a novel climate policy uncertainty index developed by Gavriilidis (2021), alongside Google Trend data index, the paper shows that uncertainty about climate regulations has both recessionary and inflationary effects, corroborating the theoretical findings. Further analysis suggests that appropriate monetary policy tools could moderate the welfare cost arising from the environmental policy uncertainty, emphasizing the need for Central Banks to adopt a more aggressive stance in stabilizing GDP and inflation in the face of environmental policy uncertainty shocks.

Welfare-maximizing patent length in a dynamic general equilibrium model

Abstract This article examines analytically the welfare-maximizing patent length in a dynamic general equilibrium model which is based on a variety expansion R&D-based growth model. The results show that if the elasticity of substitution among the intermediate goods is higher, that is, the price elasticity of demand is higher, the welfare-maximizing patent length is shorter. This article also examines the welfare-maximizing mix of patent length and breadth, and numerically obtains similar results, that is, a higher elasticity of substitution shortens the welfare-maximizing length.

Imperfect coordination in DSGE models: The resurgence of Keynes in mainstream macroeconomics

The imperfect coordination of expectations and actions is a central theme running through Keynes’s General Theory. Incorporating this theme into mainstream macroeconomics, however, has proved to be a difficult endeavour. In particular, attempts to accommodate coordination failures within Dynamic Stochastic General Equilibrium (DSGE) models through multiple equilibria and “dynamic” indeterminacy, while promising in the 1990s, were gradually abandoned in the 2000s. Since then, the “New Keynesian” framework has come to dominate macroeconomic modelling. And since the coordination of agents is not at issue in this latter framework, mainstream macroeconomics has seemed to leave the coordination theme out of its focus, if not its scope. In this paper, we challenge this perception and argue that the coordination theme is actually alive and well. We especially present two recent research programmes which, while belonging to the DSGE paradigm, give pride of place to coordination failures and share a common objective: providing, within the class of DSGE models, an alternative to the New Keynesian framework that would involve the most important ideas emerging from Keynes’s General Theory.

Green Fiscal and Tax Policies in China: An Environmental Dynamic Stochastic General Equilibrium Approach

Implementing green fiscal and tax policies for reducing emissions and pollution without negatively impacting economic growth remains a challenge. We aimed to determine whether environmental protection and economic growth can both be attained under a green fiscal and tax policy. Specifically, we created a dynamic stochastic general equilibrium (DSGE) model to explore the environmental, economic, and welfare impacts of green fiscal and tax policies. Additionally, a welfare analysis based on an environmental DSGE (E-DSGE) model was performed. We found that (1) raising the environmental or energy tax rate was beneficial for reducing emissions and environmental pollution. However, this approach inhibited economic growth, an outcome not conducive to improving welfare. (2) Increasing the subsidy rate for emission reduction not only incentivized businesses to reduce emissions but also improved economic growth and welfare. (3) The emission reduction mechanisms of environmental tax policies, energy tax policies, and subsidy policies are different. Among them, the environmental tax policy and the energy tax policy both reduce pollution by forcing businesses to increase their emission reduction efforts, but the former is a tax on pollution emissions, while the latter is a tax on energy consumption. However, emission reduction subsidy policies incentivize companies to increase their emission reduction efforts and reduce pollution emissions by alleviating their financial burden. (4) Increasing government spending on environmental remediation could promote economic growth. However, considering that this does not motivate companies to reduce emissions, increasing their share will lead to a reduction in emission reduction subsidies, ultimately negatively impacting social welfare. (5) An environmental tax would cause greater losses in welfare than an energy tax. These findings will enable policymakers to optimize expenditures and tax systems.

The coevolution effect of central bank digital currency and green bonds on the net-zero economy

Directed by the net-zero emission goal, the green bond has become an essential financial tool to promote the development of the green economy. However, the greenwashing risk makes it doubtful whether the green bond can play a positive role. Therefore, this study constructs a six-sector dynamic stochastic general equilibrium (DSGE) model to analyze whether the coevolution of central bank digital currency (CBDC) and green bonds can fully play a positive role in promoting the net-zero economy. The results indicate that: (i) Increased CBDC supply has a positive effect on the economy, and also promotes green bond financing and net-zero emissions. (ii) Compared with non-interest-bearing CBDC, the coevolution of interest-bearing CBDC and green bonds is more likely to promote the net-zero economy and enhance the effectiveness of monetary policy. (iii) When the economy is overheating or in recession, the central bank can regulate green bond financing by adjusting the CBDC interest rate to promote a net-zero economy. (iv) The coevolution of interest-bearing CBDC and green bonds will achieve a higher welfare level than non-interest-bearing CBDC. This study provides guidance for the coevolution of CBDC technology innovation and green bond financial innovation.

Can central banks do the unpleasant job that governments should do?

We investigate what happens when the fiscal authorities do not react to rising public debt so that the unpleasant task of fiscal sustainability falls upon the Central Bank (CB). In particular, we explore whether the CB’s bond purchases in the secondary market can restore stability and determinacy in an otherwise unstable economy. This is investigated in a dynamic general equilibrium model calibrated to the Euro Area (EA) and where monetary policy is conducted subject to the rules of the Eurosystem (ES). We show that given the recent situation in the ES, and to the extent that a relatively big shock hits the economy, there is no room left for further quasi-fiscal actions by the ECB; there will be room only if the ES’ rules are violated. We then search for policy mixes that can respect the ES’s rules and show that fiscal and quantitative monetary policies can reinforce each other; this confirms the importance of policy complementarities.

The substantial impacts of carbon capture and storage technology policies on climate change mitigation pathways in China

Carbon capture and storage (CCS) technology, considered as a pivotal tool in mitigating climate change within the fossil energy system, particularly in China, has experienced slower development than expected. The exploration of direct incentive policies to facilitate its growth remains relatively underdeveloped. This study developed a hybrid dynamic computable general equilibrium (CGE) model to simulate the substantial impacts of CCS incentive policies on China within the context of carbon neutrality target. Two potential incentive policies, carbon emission trading system (ETS) and 45Q tax credit, were simulated, with different sectoral coverage. The results indicate that CCS technologies can reduce carbon emissions by 960 ∼ 1,604 MtCO2 annually by 2060 through the strategic implementation of these incentive policies. The 45Q tax credit demonstrates its effectiveness in promoting early-stage research and development (R&D) and demonstration of CCS, while the ETS policy facilitates the commercial development of CCS in the later stage of development. By 2060, the implementation of CCS incentive policies could potentially result in 7.7 ∼ 17.4 % reduction in China’s primary energy consumption, 71.2 ∼ 82.7 % decrease in the carbon price of ETS and 5.64 ∼ 6.59 % increase in the GDP compared with the no-policy scenario. In addition, the sectoral output in various sectors and the welfare of urban and rural households also increase. This paper provides an important reference for the realization of China’s carbon neutrality goal and the model framework can be applied to other countries.

Impacts of demand and supply-side interventions on South Korea’s housing markets: a dynamic housing-CGE analysis

This paper examines the impacts of housing market policies in Korea by developing a dynamic computable general equilibrium model integrating regional housing markets and multiregional mobility. We compare simulation outcomes of demand- and/or supply-side approaches in housing market interventions and address how these various policy instruments affect housing prices, demand, and household welfare. Policy simulation results suggest that supply-based interventions would be more effective than housing tax policies for cooling down overheated housing markets without decreasing consumer welfare. Tax-based demand-side approaches result in a 1.8–2.2% housing price drop and a 1.1–1.2% welfare decline annually between 2021 and 2024. In the supply-side policy, investing in housing construction leads to 3.4–4.1% lower housing prices and 1.5–1.8% enhanced welfare.

The Block-Correlated Pseudo Marginal Sampler for State Space Models

Pseudo Marginal Metropolis-Hastings (PMMH) is a general approach to Bayesian inference when the likelihood is intractable, but can be estimated unbiasedly. Our article develops an efficient PMMH method that scales up better to higher dimensional state vectors than previous approaches. The improvement is achieved by the following innovations. First, a novel block version of PMMH that works with multiple particle filters is proposed. Second, the trimmed mean of the unbiased likelihood estimates of the multiple particle filters is used. Third, the article develops an efficient auxiliary disturbance particle filter, which is necessary when the bootstrap disturbance filter is inefficient, but the state transition density cannot be expressed in closed form. Fourth, a novel sorting algorithm, which is as effective as previous approaches but significantly faster than them, is developed to preserve the correlation between the logs of the likelihood estimates at the current and proposed parameter values. The performance of the sampler is investigated empirically by applying it to nonlinear Dynamic Stochastic General Equilibrium models with relatively high state dimensions and with intractable state transition densities and to multivariate GARCH diffusion-driven volatility in the mean models. Although we only apply the method to state space models, the approach will be useful in a wide range of applications such as large panel data models and stochastic differential equation models with mixed effects.

How constant is constant elasticity of substitution? Endogenous substitution between clean and dirty energy

The degree of substitutability between clean and dirty energy plays a central role in leading economic analyses of optimal environmental policy. Despite the importance, assuming a constant and exogenous elasticity of substitution has been a dominant theoretical approach. We challenge this assumption by developing a dynamic general equilibrium model with an endogenous elasticity of substitution that interacts with the relative share of clean inputs in the economy. We find strong dynamic feedback effects arising from endogenous substitution capacity that amplifies the impact of directed technical change and accelerates the transition to a green economy.

Dividend Taxation and Financial Business Cycles

We examine the interactions between different dividend tax systems and financial shocks in a dynamic stochastic general equilibrium (DSGE) model with an occasionally-binding investment credit limit. We show that dividend taxes largely determine the collateral value of assets, thereby occasionally distorting investment decisions and altering the propagation of financial shocks. Permanently lower dividend taxes dampen financially-driven business cycles in a state-contingent fashion. They also help explain substantial macroeconomic asymmetries following equally-sized expansionary and contractionary financial shocks.

Fiscal Policy for Inclusive Growth. A Case Study of Myanmar

Following decades of isolation under military rule, Myanmar initiated historic political reforms since 2011, but faces challenges translating liberalization into broad-based advancement. A dynamic stochastic general equilibrium modelling approach estimated on Myanmar data is used, with simulations quantifying potential growth and distributional impacts of strategic government expenditure reallocations towards infrastructure upgrading, agricultural investments, expanded social transfers and progressive tax reforms. Results indicate sustained infrastructure and rural productivity spending have high output multipliers while well-targeted transfers reduce income inequality. However, institutional absorptive capacities condition realization of social returns. Complementary governance enhancements like project oversight and competitiveness in public investment allocation prove vital. Regional peer benchmarking provides comparative lessons. Altogether, evidence-based fiscal reorientation towards addressing pressing human capital, rural-urban and firm competitiveness constraints can accelerate inclusive growth in Myanmar if pursued prudently. Sustainable expansion requires strengthening public financial management (PFM) systems and results monitoring.

The problems of macroeconomics as institutional problems: complementing the ‘what went wrong’ story with a social epistemology perspective

Abstract After the financial crisis of 2008, many economists expressed dissatisfaction with the state of macroeconomics. They criticised deficiencies in the dominant dynamic stochastic general equilibrium modelling approach and conceptions of good macroeconomic research behind that dominance. This paper argues that there is a deeper problem in macroeconomics, which remains unaddressed. I connect existing literature critical of the institutions of macroeconomics and of economics in general to the institutional preconditions of effective criticism outlined by the philosopher Helen Longino. I find that as an epistemic community, macroeconomics does not function in a way that adequately supports critical evaluation of established beliefs, norms and practices. This failure may partly explain why many views on macroeconomic modelling, the tenability of which economists questioned after the crisis, were able to persist for so long. My analysis gives additional support to several recent proposals for institutional reforms in economics.

A DSGE Model with Government-owned Banks

Abstract How relevant are government-owned banks in the economy, especially during recessions? We study the role of government-owned banks in a dynamic stochastic general equilibrium (DSGE) model with heterogeneous financial intermediaries, heterogeneous households, and minimum capital requirement constraints. We show that the capitalization of government-owned banks during recessions smooths the effects of a negative shock and helps the economy recover more quickly. However, these stabilizing effects could be partially offset by banks’ inefficiency in transforming one unit of capital into loans. Therefore, ignoring the heterogeneity between private and government-owned banks may lead to misleading assessments and conclusions regarding the effects of economic policies on the macroeconomic and banking variables. This is particularly important for evaluating the effectiveness of macroprudential policies.

Financial Frictions, Capital Misallocation, and Input-Output Linkages

I study how input-output linkages amplify the aggregate impact of sectoral financial distortions in a dynamic general equilibrium model with endogenous capital wedges. The aggregate impact of a shock can be decomposed into weighted productivity changes and changes in allocative efficiency. A systematic uncertainty shock induces heterogenous responses in sectoral capital wedges, reducing allocative efficiency and aggregate total factor productivity (TFP). However, idiosyncratic sectoral uncertainty shocks may improve allocative efficiency and raise TFP. I then calibrate the model to US data. The network amplification magnitude on aggregate TFP ranges from 1.58 to 1.7. (JEL E22, E23, E25, E32, E44, G20, G30)

Identifiability and estimation of possibly non-invertible SVARMA Models: The normalised canonical WHF parametrisation

This article focuses on the parametrisation, identifiability, and (quasi-) maximum likelihood (QML) estimation of possibly non-invertible structural vector autoregressive moving average (SVARMA) models. SVAR models are routinely adopted due to their well-known implementation strategy. However, for various economic and statistical reasons, multivariate SVARMA settings are often more suitable. These settings introduce complexity in the analysis, primarily due to the presence of the moving average (MA) polynomial. We propose a novel representation of the MA polynomial matrix using the Wiener–Hopf factorization (WHF). A significant advantage of the WHF is its ability to handle possible non-invertibility and thus models with informational asymmetry between economic agents and outside observers. Since solutions of Dynamic Stochastic General Equilibrium (DSGE) models often involve this informational asymmetry, SVARMA models in WHF parametrisation can be considered data-driven alternatives to DSGE models and used for their evaluation. Furthermore, we provide low-level conditions for the asymptotic normality of the (Q)ML estimator and analytic expressions for the score and information matrix. As application, we estimate the Blanchard and Quah model, and compare our results and implied impulse response function with the ones in the SVAR model by Blanchard and Quah and a non-invertible SVARMA model by Gouriéroux and co-authors. Importantly, we have implemented this novel method in a well-documented R-package, making it readily accessible for researchers and practitioners.

The Response of Macroeconomic Variables to Government Spending Shocks in the Sudanese Economy 1989-2019: Comparing the Structural Shocks (DSGE Approach) and Impulse Response (SVAR Model)

The importance that different (approaches and models) to modeling the macroeconomy place on theoretical coherence compared to their capacity to match the data and the quality of the econometric model description varies. Dynamic stochastic general equilibrium (DSGE) models are more theoretical, whereas vector autoregression (SVAR) models provide a better match to the data. For developed economies, there are well-established publications on measuring the response of economic indicators to government spending shocks and aggregate macroeconomic activity. In addition, such empirical studies in emerging nations are scarce. This research seeks to fill this void by utilizing the DSGE model and the SVAR approach to investigate the influence of the response of macroeconomic variables to government spending shocks in the Sudanese economy from 1989 to 2019. The findings indicate that the influence of government expenditure shocks on the Sudanese economy is inconsistent with Keynesian principles, as some selected macroeconomic indicators do not respond positively to government expenditure shocks. The non-responsiveness of the inflation rate and exchange rate to government expenditure shocks is demonstrated; this finding may indicate the monetary authority’s weakness in managing monetary variables in the Sudanese economy. In most situations, fiscal and monetary policies were in sync, and “double expansionary” and “double contractionary” policy coordination may be the proper approach; and also create tools that fit the Sudanese economy’s structure.

Economic implications of carbon neutrality in China: A dynamic general equilibrium analysis

We utilize a dynamic computable general equilibrium model to analyze the economic implications of carbon neutrality for China. Novel treatments of power generation and carbon capture and storage (CCS) possibilities are a feature of the analysis. We calculate the impact of carbon neutrality by comparing a business-as-usual base-case scenario with results from an alternative carbon neutrality scenario. We discuss the assumptions used in these scenarios and shocks relating to energy efficiency, energy preferences, and the implementation of CCS. Our simulation results show that macroeconomic (especially employment) setbacks are minor, suggesting that China should be able to achieve the joint policy goals of both net carbon neutrality by 2060 and doubling real gross domestic product by 2035. We also test the sensitivity of our core results to changes in key underlying assumptions.

Modelling the socio-economic impacts of coal-fired electricity phaseout under carbon neutrality target: A dynamic CGE-based study of China

Given its significant carbon emissions, the phaseout of coal-fired electricity emerges as a crucial strategy in achieving the goal of carbon neutrality, which will fundamentally reshape China's social-economic landscape. In this study, a dynamic computable general equilibrium (CGE) model was constructed to evaluate the economic and social ramifications of phasing out coal-fired electricity, encompassing diverse pathway scenarios. The results suggest that the phaseout of coal-fired electricity will significantly influence the socio-economic system compared to the Business as Usual (BAU) scenario. Different phaseout scenarios are projected to yield a cumulative decrease in carbon dioxide emissions ranging from 36.38 to 60.15 Gt between 2020 and 2060. Consequently, there will be a cumulative GDP ranging from 22.22 to 36.29 trillion yuan, accompanied by a cumulative decline in employment affecting 23.68 to 29.92 million individuals. The anticipated trends in annual GDP and job losses are expected to exhibit a U-shaped curve, initially increasing, and then decreasing from 2020 to 2060 compared to the BAU scenario. A distinct trade-off is anticipated to arise between the potential for carbon reduction and the resultant losses in jobs and economic output. The more optimistic scenario, characterized by a lower peak value, an earlier peak time, and a later phaseout time, is projected to result in a relatively lower socioeconomic impact per unit of CO2 emissions reduction. These findings provide policymakers with vital insights, informing the development of strategies for a gradual transition away from coal-fired electricity while minimizing socio-economic repercussions.

Quantifying the Effect of Change in Rainfall Dynamics on Agricultural Output in Nigeria

Agricultural production has clearly gained acceptance, as a crucial approach to meeting the food consumption needs of Nigeria’s growing population as well as an important requirement for achieving food security. Hence, the objective of this paper is to quantify the effect of change in rainfall dynamics on agricultural output in Nigeria employing a Dynamic Computable General Equilibrium model and using data from the 2019 Social Accounting Matrix. The results revealed that rainfall shocks had an adverse effect on the four components of agricultural output considered such as crops, livestock, fishery and forestry in the short and long term. It also had a negative effect on aggregate agricultural output compared to the baseline scenario. Therefore, public policy towards investing heavily in rain harvesters cannot be overemphasized. There is the need for policy efforts towards targeted interventions that provide an enabling environment and the necessary infrastructures for private investments in agriculture, address climatic risks and build resilience among farmers.