Optimal Policy Mix Research Articles

Equilibrium effects of payroll tax reductions and optimal policy design

We quantify the unintended effects of a low-wage payroll tax reduction using an equilibrium search model featuring bargaining, worker and firm productivity heterogeneity, labor taxes, and a minimum wage. The decentralized economy is inefficient due to search externalities and labor market policies. We estimate the model using French data and find that a significant reduction in low-wage payroll taxes in 1995 leads to an overall improvement in economic efficiency by increasing employment and correcting existing policy distortions that disincentivize labor force participation. However, the tax reduction, by increasing labor force participation among low-productivity workers and vacancy postings by low-productivity firms, results in negative but minor spillover and reallocation effects due to congestion. We find that the optimal policy mix is a lower minimum wage and lower payroll taxes compared to the policies in place in the early 1990s.

Would macro policy promote green and low-carbon transformation of energy companies?

Promoting energy efficiency optimization and upgrading the energy structure is a crucial pathway for energy companies to achieve a green and low-carbon transformation. This paper first constructs an endogenous growth E-DSGE model to analyze the impact of environmental regulation policy on energy efficiency optimization and carbon reduction. It further investigates the role of targeted monetary policy in advancing energy structure upgrade and estimates the optimal regulatory policy mix for carbon reduction transformation. The findings indicate that while environmental regulation policy can enhance energy efficiency, their effects are limited and may not support expanded production. Targeted monetary policy, however, can gradually upgrade energy structures while ensuring energy supply. The optimal combination of macroeconomic control policies can enhance social welfare and promote the green and low-carbon transformation of energy firms. Policy recommendations include formulating a comprehensive macroeconomic strategy, utilizing environmental regulations to promote energy efficiency, and employing targeted monetary policy to advance energy infrastructure upgrades. By coordinating fiscal, monetary, and environmental policies, the green and low-carbon transformation of energy firms can be effectively supported.

Clean innovation, heterogeneous financing costs, and the optimal climate policy mix

Access to finance is a major barrier to clean innovation. We incorporate a financial sector in a directed technological change model, where research firms working on different technologies raise funding from financial intermediaries at potentially different costs. We show that, in addition to a rising carbon tax and a generous but short-lived clean research subsidy, optimal climate policies include a clean finance subsidy directly aimed at reducing the financing cost differential across technologies. The presence of an endogenous financing experience effect induces stronger mitigation efforts in the short-term to accelerate the convergence of heterogeneous financing costs. This is achieved primarily through a carbon price premium of 39% in 2025, relative to a case with no financing costs.

Green industrial policy can strengthen carbon pricing but not replace it

Carbon pricing has received prominent support as the key policy to reduce greenhouse gas emissions. Yet, in the context of heightened geopolitical tensions and risks of supply chain disruptions, policy makers are increasingly resorting to green industrial policies to support the deployment of clean energy technologies. This Perspective discusses whether this development represents a paradigm shift in the design of climate policies and assesses arguments for and against carbon pricing and green industrial policies. Our analysis addresses implications for economic efficiency, security of supply, distributional concerns and political economy issues. We find that green industrial policies can support carbon pricing by lowering market barriers for clean technology diffusion and strengthening political support for climate policy. Yet, we also emphasize that a carbon price should be an essential element in any effective climate mitigation policy mix and the key is to find the optimal policy mix for carbon pricing and green industrial policies for the unique context of each location. In the EU, green industrial policy should mainly be employed to complement carbon pricing and deal with additional market barriers. In the US, by contrast, green industrial policy could be used strategically to try to build political support for and reduce resistance to a carbon price.

The economic impact of general vs. targeted lockdowns: New insights from Italian municipalities

In response to COVID-19, most governments implemented either general or geographically targeted lockdowns. While the contractionary effects of general lockdowns have been well-documented, this paper is the first to contrast the economic impacts of the two approaches in a quasi-experimental setting. To this aim, we construct a high-frequency database combining unique information from mobile devices and administrative data across Italian municipalities. Using difference-in-differences approaches, our results confirm that general lockdowns considerably reduced mobility and employment, but we also find that localised measures only led to modest declines in mobility with minimal additional impact on employment. Focusing on the distributional consequences, we show that economic activity decreased less in wealthier communities with a higher capacity for telework. Moreover, short-time work schemes, serving as automatic stabilizers, predominantly benefited affluent areas. We conclude that an optimal policy mix involves targeted lockdown measures, complemented by adequate social policies and infrastructure investment.

On the interactive effects of climate policies: Insights from a stock-flow consistent model

Climate policies such as carbon tax and green finance policy are critical measures to promote low-carbon transition worldwide. These policies are, however, likely to interact with each other and create unintentional consequences. This paper adopts a stock-flow consistent model to theoretically explore the effects of policy interactions. Specifically, commercial banks, as the key credit creators and critical players in providing source of finance, are included. Based on the numerical simulations of the dynamic model, we find that both carbon tax and green finance policies render positive impacts on low-carbon transition. In addition, green credit incentives, if imposed simultaneously with carbon tax, can enhance the positive effects. Although low-carbon transition could generate higher net government revenues, our results show that banking sector tends to expose to higher financial risks when firms’ debt-equity ratio rises. Further analysis shows that subsidies on green loans can support green transition and bring positive consequences to debt rollover and social welfare, indicating the needs for active government intervention to improve policy effectiveness. The framework proposed in this paper provides a useful way to understand policy dilemmas in pursuing low-carbon transition and give important implications to form optimal policy mix.

Commercial policies, unilateral versus bilateral foreign ownership, and welfare

AbstractThis paper examines how cross‐border ownership and restrictions affect commercial policies optimally chosen by the government of an importing country. Focusing on import competition in an oligopoly market served by two local producers and a foreign firm, we study and compare two partial ownership arrangements without corporate control: unilateral ownership by the foreign firm over a local producer and bilateral ownership between the two entities. The main findings are as follows: (i) When foreign ownership is unilateral, the optimal trade and industrial policies are an import tariff and a production subsidy, respectively. (ii) When foreign ownership is bilateral, the trade policy can be an import subsidy, and the industrial policy is a production subsidy. These results differ from the benchmark equilibrium without ownership, under which the optimal policy mix consists of an import tariff and a production subsidy. (iii) Unilateral foreign ownership always reduces domestic welfare. However, bilateral foreign ownership can increase domestic welfare when local producers' cost disadvantages are substantially high. (iv) Considering the usual lump‐sum transfer for a balanced budget, bilateral ownership entails a lower public burden than two other scenarios for the government to finance its strategic use of trade and industrial policies.

Comprehensive effects of policy mixes on the diffusion of heavy-duty hydrogen fuel cell electric trucks in China considering technology learning

Heavy-duty hydrogen fuel cell electric trucks (HD-FCETs) will play a pivotal role in achieving carbon neutrality in transportation in China. However, high cost has hindered its commercial diffusion, resulting in the dependence on financial policy support. With the phasing out of purchase subsidies, new policy mixes should be proposed. Therefore, a modified generalized Bass model based on technology learning is established to investigate the comprehensive effects of various policy mixes on the HD-FCETs diffusion including tractor-trailers, dump trucks, and straight trucks. About 113 policy mix scenarios - consisting of one or more policy tools from sales ban policy, hydrogen subsidy, and purchase tax - are simulated. The obtained results reveal that: (i) All policy mix scenarios can increase the ownership amount of HD-FCETs by 1.92%–35.7% by 2060 compared with no policy scenario; (ii) The most efficient policy mix scenario can reduce the cumulative social costs from 323.69 billion CNY to 210.3 billion CNY, while inappropriate policies and no technological advances could increase the cumulative social costs to 356.6 billion CNY and 732.6 billion CNY respectively; (iii) Among these policy tools, the sale ban policy is indispensable, moreover, both the HD-FCET classes and the policy intensity can affect the optimal policy mix choice.

Macroeconomic Stability and Optimal Policy Mix

Public welfare and macroeconomic stability should be the main objectives of fiscal and monetary policy cooperation. Monetary and fiscal policy should be coordinated better to maintain sustainable economic development. To implement fiscal measures and monetary controls, a balanced budget is necessary. This study uses data from 1976 to 2022. A macroeconomic stability check uses real GDP, current account balance, exports, real effective exchange rate, broad money (M2), foreign exchange reserves, consumer price index (CPI), nominal exchange rate, government expenditures, and government tax revenue. The VAR models we use are Impulse Response Functions (IRFs) and Variance Decompositions (VDs). CMR feels a negative impact, TRY, whereas M2G, GY, and others feel a positive impact. Achieving output and price stability requires higher call money rates, more tax revenues, and reduced government spending. Output gaps should be negative.M2G and CABY are negatively correlated, whereas CABY and CMR are positively correlated. If there is a negative output gap, monetary aggregates and taxes conflict with price and production stability; however, policy should aim to increase the current account balance. We recommend strict fiscal and monetary policy measures to stabilize output and limit inflation whenever there is a positive output gap. In addition to strengthening trade and foreign exchange reserves, reduced government spending will stabilize exchange rates; however, increasing tax revenue will counteract these benefits by strengthening the current account.

No country is an island. International cooperation and climate change

We explore the cross-country implications of climate-related mitigation policies. Specifically, we set up and estimate a three-country, two-sector (brown vs green) DSGE model with negative production externalities stemming from carbon-dioxide emissions. The model is used to characterize the welfare-enhancing equilibrium under alternative containment policies. According to the optimal policy mix: i) fiscal policy focuses on reducing emissions; ii) countries cooperate with each other to reduce the losses generated by climate policies; iii) monetary policy looks through environmental objectives but adapts its strategy when the costs of the environmental transition materialize. All other policy combinations either fall short of the Paris agreement's objective or are not incentive-compatible, i.e. the implied short-term losses would prevent the implementation of efficient long-term climate policies.

Fiscal or monetary? Efficacy of regulatory regimes and energy trilemma of the inflation reduction act (IRA)

This paper examines the relative effectiveness of fiscal and monetary policies in achieving the goals of the Inflation Reduction Act of 2022 (IRA), a historic legislation that addresses the energy trilemma of security, inflation, and sustainability, while also promoting growth and employment in the U.S. The IRA relies mainly on fiscal measures, such as subsidies and stimulus packages, which can create deficit or surplus depending on the tax revenues. However, some of the IRA goals, such as inflation, growth, and employment, are largely influenced by monetary factors, which suggests the possibility of using monetary policies as alternative or complementary instruments in the IRA. Using a macroeconomic model, we compare the impacts of fiscal and monetary policies on the IRA outcomes and find that the monetary policy is more effective than the fiscal policy in achieving the IRA objectives, especially in the post-covid period. Our results have important implications for policymakers who need to evaluate the optimal policy mix for the successful implementation of the IRA.

Human capital and pensions with endogenous fertility and retirement

AbstractWe study an OLG model with child policies and a PAYG pension with endogenous retirement and fertility. The result of the planned economy is compared to the decentralized competitive equilibrium deriving optimal policies. We show that in the presence of a PAYG pension system, the optimal policy mix includes an education subsidy and a subsidy for the supply of labor in old age. Fertility should be taxed or incentivized depending on whether there is full or partial retirement, and on the parameters. We focus on the parameter reflecting the deterioration of human capital and show that a child tax may be required.

The Implication of Fiscal Variables in the Monetary Reaction Function of Pakistan

This paper investigates the influence of fiscal variables on the monetary reaction function innPakistan. The main concern of a macroeconomic policy is to achieve sustainable growth and to keep a low level of inflation in the economy. For empirical analysis, the Autoregressive Distributive Lag model (ARDL) is applied using quarterly data for the period 2004Q1 to 2020Q4. The empirical evidence reveals that the monetary policy instrument in the monetary reaction function is explained significantly by the fiscal policy variables both in the short and long-run. Monetary policy independently cannot control inflation unless it has the support of the fiscal policy. Therefore, for an optimal policy mix, a wise monetary policy must be followed by a comprehensive fiscal policy in the case of Pakistan.

Beyond the LTV Ratio: Lending Standards, Regulatory Arbitrage, and Mortgage Default

AbstractBooming house prices are historically correlated with loose lending standards. Nonetheless, in Spain the loan‐to‐value (LTV) ratio failed to capture imbalances during the last housing boom. Using loan‐level data from millions of mortgages we show that inflated collateral valuations, used by banks as a mechanism to circumvent regulation, distorted the informative value of LTV, and masked the accumulation of risk. We identify that regulation relying upon a single measure is more prone to suffer from regulatory arbitrage, and that the optimal policy mix varies over the financial cycle. Overall, our study provides useful insights for the implementation of borrower‐based measures.

Testing policy effectiveness during COVID-19: An NK-DSGE analysis

We examine the effectiveness of fiscal and monetary policy in mitigating the impact of COVID-19 in India using the NK-DSGE framework. In terms of policy effectiveness, our findings imply that expansionary monetary policy is effective in reviving economic growth both from the demand side and supply side. In contrast, expansionary fiscal policy is effective only from the supply side. Our findings recommend the implementation of optimal policy mix in a coordinated and staggered framework for effective mitigation of ill-effects of the COVID-19, such as reviving employment and capacity utilization to its pre-pandemic level with minimal inflationary effects.

Optimal fiscal policy under capital overaccumulation

AbstractIn a canonical model of heterogeneous agents with precautionary saving motives, Aiyagari [(1995) Journal of Political Economy103(6), 1158–1175.] breaks the classical result of zero capital tax obtained in representative-agent models. Aiyagari argues that with capital overaccumulation the optimal long-run capital tax should be strictly positive in order to achieve aggregate allocative efficiency suggested by the modified golden rule (MGR). In this paper, we find that, depending on the sources of capital overaccumulation, capital taxation may not be the most efficient means to restore the MGR when government debt is feasible. To demonstrate our point, we study optimal policy mix in achieving the socially optimal (MGR) level of aggregate capital stock in an infinite horizon heterogeneous-agents incomplete-markets economy where capital may be overaccumulated for two distinct reasons: (i) precautionary savings and (ii) production externalities. By solving the Ramsey problem analytically along the entire transitional path, we reveal that public debt and capital taxation play very distinct roles in dealing with the overaccumulation problem. The Ramsey planner opts neither to use a capital tax to correct the overaccumulation problem if it is caused solely by precautionary saving—regardless of the feasibility of public debt—nor to use debt (financed by consumption tax) to correct the overaccumulation problem if it is caused solely by production externality (such as pollution)—regardless of the feasibility of a capital tax. The key is that the MGR has two margins: an intratemporal margin pertaining to the marginal product of capital (MPK) and an intertemporal margin pertaining to the time discount rate. To achieve the MGR, the Ramsey planner needs to equate not only the private MPK with the social MPK but also the interest rate with the time discount rate—neither of which is equalized in a competitive equilibrium. Yet public debt and a capital tax are each effective only in calibrating one of the two margins, respectively, but not both.

The Economics of Deferral and Clawback Requirements

ABSTRACTWe analyze the effects of regulatory interference in compensation contracts, focusing on recent mandatory deferral and clawback requirements restricting incentive compensation of material risk‐takers in the financial sector. Moderate deferral requirements have a robustly positive effect on risk‐management effort only if the bank manager's outside option is sufficiently high; otherwise, their effectiveness depends on the dynamics of information arrival. Stringent deferral requirements unambiguously backfire. Our normative analysis characterizes whether and how deferral and clawback requirements should supplement capital regulation as part of the optimal policy mix.

Farm‐level impacts of the CAP post‐2020 reform: A scenario‐based analysis

AbstractWe analyze the farm‐level economic and environmental impacts of the post‐2020 reform of the Common Agricultural Policy (CAP) of the European Union, examining six scenarios constructed around the budget allocated to eco‐schemes and the stringency of enhanced conditionality. Results suggest that the CAP post‐2020 can improve environmental performance but at a cost for farms. Enhanced conditionality appears to play a greater role than eco‐schemes in delivering environmental improvements. The new CAP provides the Member States ample options to choose among different measures. The optimal policy mix will depend on the balancing of income support versus environmental performance that reflects policy priorities.

The Relevance of an Optimal Policy Mix in the CEMAC Zone

The Relevance of an Optimal Policy Mix in the CEMAC Zone

Evaluation of Stackelberg Leader-Follower Interaction Between Policymakers in Small Open Economies

The problem of coordination between policymakers seems to have created fundamental problems related to economic and social costs, targeted inflation, potential growth, and a high budget deficit. To resolve these problems in this framework, it is important to see the results of the interaction between policymakers and to propose an optimal policy strategy. In this study, the interactions between monetary and fiscal policymakers are examined game theoretically within the framework of the New Keynesian model. The strategic interaction between these policymakers is assessed using the DSGE (Dynamic Stochastic General Equilibrium) model for a small open economy. From this point of view, the interaction between policymakers is assessed within the framework of hypothetical scenarios. The optimal monetary and fiscal policies for a small open economy are derived from the leader-follower mechanism solution known as the Stackelberg solution. Optimal Stackelberg policy rules derived for a small open economy contribute to the literature of economics. The performance of the game theoretically derived optimal policy rules is evaluated through dynamic simulation within the framework of counterfactual experiments. The parameters developed for the model are calibrated for the Turkish economy. Dynamic simulation of the models, the impulse response functions, and the social loss analysis shows that the optimal policy mix for the Turkish economy is when the monetary policymaker is the leader, and the fiscal policymaker is the follower.