Real Business Cycle Research Articles

Application of Dsge Models for the Analysis of Latvian Economic Processes

Nowadays DSGE models are the mainstream of macroeconomic theory. DSGE stands for dynamic, stochastic, general equilibrium and the main purpose of these models is to perform the analysis of business cycle fluctuations and economic policy. The main advantage of DSGE models is related to their theoretical foundations – the dynamics of economic processes is described as interaction of rational optimizing agents, which react to "exogenous stochastic disturbances" (shocks). These advantage of DSGE models helps to analyse both economic processes on the aggregated level and individual markets under the circumstances of uncertainty. Historically, DSGE models have gone through several stages of development. The origins of DSGE models are related to Lucas critique – a series of papers, which presented a new approach of macroeconomic processes analysis. This approach was rather controversial with Keynesian theory. In the terms of R. Lucas, macroeconomic models must be based on microfoundations and consider expected variables, because the consideration of expectations in macroeconomic models best describes "the real economic situation" and makes these models suitable for economic policy development and analysis. The first DSGE models were basically RBC (Real Business Cycle) models, but their main drawback was assumption of neutrality of money, which made them not suitable for monetary policy analysis. Later DSGE models correct this drawback – contemporary DSGE models are used for various purposes, for instance, fiscal and monetary policy analysis. Keywords: macroeconomic modelling, DSGE, Latvian economy

Processing inflation news: A discussion of Binz, Ferracuti, and Joos (2023)

Binz, Ferracuti, and Joos (2023) examine whether better internal information systems can mitigate the association between inflation and investment. According to Real Business Cycle models, inflation should not impact real decisions like investment, yet empirically the two are positively related. Lucas (1972) theorizes that imperfect information can cause agents to rationally extrapolate from their local set of information to make conclusions about what is happening in aggregate. Motivated by this model, the authors argue that better internal information systems allow managers to disentangle firm-level real shocks from nominal shocks. My discussion evaluates the measurement of internal information quality and questions how distinct it is from external information quality. Next, I relate the findings to a growing literature that examines how individuals and firms form economic expectations. Finally, I consider whether and how these findings can inform policy.

Educational games in the system of economic education

Relevance. The Monopoly game is a popular board game with a simple concept that is relevant as a tool for enterprises and entrepreneurs in the system of teaching the basics of business, as a tool for studying strategic economics and justifying business strategies. Goals. Substantiation of the importance of the Monopoly game model as a business strategy tool for developing skills in strategic thinking, negotiation, risk management and efficient resource allocation. Exploring the similarities between concepts in the game and real economic concepts, including monopoly, market competition, pricing strategies, and business cycles. Evaluation of the effectiveness of the use of “Monopoly” as an educational tool for teaching the concepts of strategic economics. Methodology. Analysis, synthesis, observation, comparative and statistical methods. Conclusions. The business game “Monopoly” is a useful tool in the system of teaching economic concepts, raising the level of knowledge of the real economy. The use of the game model “Monopoly” in the educational process develops critical thinking and the skills of effective management decisions focused on business development.

The Effects of Government Expenditure on the Output: A Real Business Cycle Analysis for the Romanian Economy

Abstract One of the most researched topics in macroeconomics is the development and implementation of Real Business Cycle models. This article presents a small Real Business Cycle model, which is built for the Romanian economy, with data from the 2nd quarter of 1995 through the 3rd quarter of 2022. The main aim of this analysis is to assess the historical influence of exogenous and government spending shocks on economic growth. In order to obtain accurate results, we implemented a Bayesian estimation technique for calculating the parameters of the model. The main findings indicate the significant exogenous shocks effect on the Romanian economy, and the way in which government spending had a positive effect on increasing economic growth for the period between the 1st quarter 2000 and the 3rd quarter of 2022.

Macroeconomic impacts of COVID-19 pandemic first wave in the world

The paper seeks to identify the essential global-economic macro-shocks resulting from efforts by consumers, firms, or government policies to reduce social distancing, which caused a sharp temporary change in the world economy during the pandemic outbreak in the second quarter of 2020. The purpose is fulfilled using a simple two-period real-business cycle model. The observed reaction of the global economy in the second period of 2020 is measured by the deviation of the time series of GDP and its components, labor, labor income, and average labor product in the USA and EU from the log-quadratic trend. The model can replicate the observed economic response by reducing the total factor productivity, labor demand, and labor supply—no need to assume sticky prices. As a sudden drop in performance is supposed, followed by a modest recovery already in the following period, it is not assumed that the government would be able to avert it in time with fiscal or monetary policy. Moreover, the assumption of variable prices and supply-side shocks does not support such a policy.

Sources of Business Cycle Volatility in the Indian Economy

This study investigated the sources of economic fluctuation in the Indian economy. To assess this objective, time-based and frequency-based filters are applied to extract the business cycle from the Gross Domestic Product. Further, a causal link between the business cycle and its different sources was explored using Markov’s regime-switching regression. The results indicated that total factor productivity, oil supply, and monetary policy increased business cycle volatility. Furthermore, although the fiscal policy remained unaffected, trade increased economic fluctuations during the pro-market regime. The findings suggested that the views of the real business cycle and monetarist schools of thought hold true for economic fluctuation in India, as opposed to the Keynesian view.

Aggregate Properties of Open Economy Models with Expanding Varieties

Abstract We present a unified framework to study interconnections between business cycle and international trade models. This unified framework is built upon the standard competitive, representative-firm international real business cycle model and features production externalities in the intermediate and final goods sectors. Our main theoretical result is that this unified framework is equivalent in aggregate implications to dynamic international trade models featuring monopolistic competition, endogenous entry and exit, and heterogeneous firms. We show that a negative capital externality in the intermediate good sector is required to fit the data. This presents a puzzle for the literature because when viewed through the lens of our unified framework, we demonstrate that the standard assumptions used in dynamic trade models imply a positive capital externality.

Real exchange rate misalignment and business cycle fluctuations in the Asia‐Pacific

AbstractReal exchange rate (RER) misalignment, which is the deviation between the actual real exchange rate from its equilibrium, occurs frequently among developing countries. Studies have shown that RER misalignment may have negative economic implications, such as a decline in economic growth, exports, and export diversification and an increased risk of currency crises and political instability. Using quarterly data for 22 sample countries from 1990 to 2018, this paper investigates the impact of RER misalignment on business cycles in the Asia‐Pacific by employing a panel vector autoregression involving consumer price index (CPI) inflation, output gap, short‐term interest rates, and RER misalignment. We find that RER overvaluation may reduce CPI inflation and short‐term interest rates. We also find that the Asia‐Pacific region is highly heterogeneous in that the output gaps of some countries, particularly from the Southeast Asian region, are more susceptible to RER misalignment shocks.

Pollution and labor market search externalities over the business cycle

We study the relationship between unemployment, environmental policy, and business cycles. We develop a dynamic stochastic general equilibrium real business cycle model that includes both a pollution externality and congestion externalities from labor market search frictions. These frictions generate unemployment on the extensive margin and affect hours worked on the intensive margin. We consider two policies to address the market failures: an emissions tax and a tax or subsidy on job creation. With both policies present, the efficient outcome can be achieved. When one policy is constrained or absent, we solve for the second best. The absence of a vacancy policy to address the congestion externalities substantially affects the value of the emissions tax, both in steady state and over the business cycle.

Confronting increases to labour and capital taxes to finance the pension deficit in the Dominican Republic: a real business cycle approach

Ageing demographics have prompted widespread pension reforms across Latin America. This has left several countries with a significant financial burden related to the transition from one system to another. In this article, we evaluate two alternative methods of financing the recent pension reform in the Dominican Republic. We build on a simple real business cycle model with perfect competition and add a fiscal block that allows us to simulate shocks to the tax rates on capital and labour, based on the present value of the pension reform cost. We find that increasing the tax rate on returns to capital would not only fill the pension deficit, but also have a significantly smaller adverse effect on the macroeconomy, when compared with an increase to the tax on labour.

A Literature Study on Business Cycle Theory

Business cycle theory is always a research focus during the last couple of decades as a tool to explain the fluctuation in economic growth. In chronological order, this review sorts out the theories trying to explain the business cycle into five main influential schools of economics based on previous studies: Keynesian economics, Monetarism, New classical economics, Real business cycle theory, and New Keynesian economics. This review summarizes these theories respectively, introducing their origins, main mechanism, related models and empirical evidence, drawbacks, and challenges they face from other economists. Meanwhile, this review also compares the differences and similarities between each theory from three aspects: the determinant of aggregate production, the driving force of the business cycle dynamics, and the effectiveness of fiscal and monetary policies. The motivation is to gain a general view of modern business cycle theory to provoke thinking in long-term growth and short-term fluctuations in economic activities to support further research.

Optimal Environmental Policy for Heterogeneous Governments in China

The purpose of the article is to study how the shift in the developing philosophy of China's central leadership has impacted the management style of China's local governments and, in turn, the country's economic and environmental equilibrium. We use a real business cycle model with environmental variables and divide governments into those with/without environmental concerns and into those with long- and short-term policy horizons. We find that forcing local governments to plan in the long run is effective only when those governments are simultaneously mandated to consider the environment to be as important as the economy. Theoretical results show that both output and pollution levels are highest under governments without environmental obligations, intermediate under long-term governments with environmental obligations, and lowest under short-term governments with such obligations.

PARA ARZI VE REEL GELİR ARASINDAKİ İLİŞKİNİN ASİMETRİK BİR ANALİZİ: MIST ÜLKELERİ İÇİN PARASALCI VE REEL İŞ DÖNGÜSÜ HİPOTEZLERİNİN TESTİ

This article aims to examine the asymmetric money-income relationship in MIST countries. For this purpose, Hatemi-J Panel Hidden Cointegration, asymmetric panel causality, FMOLS and DOLS tests were applied. Asymmetric causality test results reveal that there is a bidirectional causality between money supply and real income. The real business cycle hypothesis claims that the growth in the money supply is due to real income and not vice versa. The finding obtained as a result of asymmetric causality supports both monetary and real business cycle hypotheses for MIST countries. The result is that positive and negative cumulative real money supply shocks affect positive and negative cumulative real income in the economy; Similarly, they state that positive cumulative real income shocks also affect positive real income. Monetary authorities should regulate the money supply and real income independently of the positive and negative shocks in the market in order to eliminate the economic problems experienced as a result of sudden shocks in MIST countries and to stabilize the markets.

Effect of sticky Wages on the Behavior of Economic Agents with Heterogeneous Expectations

The aim of the work is to analyze the changes and behavioral features of economic agents when wage rigidity is incorporated into the new Keynesian model in comparison with the model with flexible wages and rigid prices under cognitive constraints of agents. The relevance of the work lies in the fact that the model under study is able to describe the typical features of the movement of a real business cycle. The working hypothesis is an assumption that the forecasting of the output gap, inflation of prices and wages occurs with the help of fundamentalist and extrapolation rules. The first rule is based on the prediction of the studied variables based on their stationary values. The second rule is based on the extrapolation of the latest available data for the variables under study. The weight shares of agents applying these heuristic rules change endogenously, which is the source of endogenous waves of optimism and pessimism, and the scientific novelty of the analysis of models with an imperfect labor market. An analysis of the impulse responses of an interest rate shock and a technological shock suggests that a more flexible economy (an economy with flexible wages and rigid prices) is less prone to an abrupt economic cycle caused by waves of optimism and pessimism than a more rigid economy. These shocks cause ripple effects in the economy, meaning that a tight economy will be more prone to booms and busts driven by alternating optimism and pessimism than an agile economy. It is concluded that the difference between the degree of optimism and pessimism in the base model, as well as in the model with rigid wages and prices, is the full trust of agents in the Central Bank in targeting wage inflation in the absence of stabilization of this inflation by the bank. The practical significance of the work lies in the fact that the results obtained may be useful in stabilizing the considered variables under the monetary policy of the Central Bank.

A Small Open Economy DSGE Model for Pakistan

In recent years there has been a growing interest in academics, international policy institutions and central banks1 in developing small-to-medium, even large-scale, open economy macroeconomic models called Dynamic Stochastic General Equilibrium (DSGE) models based on new-Keynesian framework.2 The term DSGE was originally used by Kydland and Prescott (1982) in their seminal contribution on Real Business Cycle (RBC) model. The RBC model is based on neoclassical framework with micro-founded optimisation behaviour of economic agents with flexible prices. One of the critical assumptions of this model is that fluctuations of real quantities are caused by real shock only; that is, only stochastic technology or government spending shocks play their role. Later research in DSGE models however included Keynesian short-run macroeconomic features (called nominal rigidities), such as Calvo (1983) type staggered pricing behaviour and Taylor (1980) type wage contracts. Hence this new DSGE modeling framework labeled as new-neoclassical synthesis or new-Keynesian modeling paradigm. 3 This new approach combines micro-foundations of both households and firms optimisation problems and with a large collection of both nominal and real (price/wage) rigidities that provide plausible short-run dynamic macroeconomic fluctuations with a fully articulated description of the monetary policy transmission mechanism; see, for instance, Christiano, et al. (2005) and Smets and Wouters (2003). The key advantage of modern DSGE models, over traditional reduce form macroeconomic models, is that the structural interpretation of their parameters allows to overcome the famous Lucas critique (1976).4 Traditional models contained equations linking variables of interest of explanatory factors such as economic policy variables. One of the uses of these models was therefore to examine how a change in economic policy affected these variables of interest, other things being equal. In using DSGE models for practical purposes and to recommend how central banks and policy institutions should react to the short-run fluctuations, it is necessary to first examine the possible sources,5 as well as to evaluate the degree of nominal and real rigidities present in the economy. In advanced economies, like US and EURO area, it is easy to determine the degree of nominal and real rigidities as these economies are fully documented. In developing economies like Pakistan, where most of economic activities are un-documented (also labeled as informal economy, black economy, or underground economy), it is very difficult to determine the exact degree of nominal and real rigidities present in the economy. However, one can approximate results using own judgments and through well defined survey based methods

New Keynesian Phillips Curve for Pakistan

Recently macroeconomists have moved to a new neo-classical synthesis by integrating Keynesian features like imperfect competition and nominal rigidities with dynamic stochastic general equilibrium model of the Real Business Cycle Theory with micro foundations and rational expectations, [see, for instance, McCallum and Nelson (1999)]. The standard model comprises of a trinity; consumption and inflation adjustment equations with a monetary authority’s reaction function. One of the pillar of the modelinflation adjustment equation, also known as New Keynesian Phillips Curve (NKPC) in the literature, has at least two important features; unlike the traditional Phillips curve the NKPC is forward-looking; and it has been derived from the profit maximising behaviour of the firms in a monopolistically competitive market structure.

Leverage cycles, growth shocks, and sudden stops in capital inflows

Using a quarterly panel of 98 advanced as well as emerging and developing countries from 1990 to 2018, this paper examines covariates of sudden stops in capital inflows. It shows that domestic variables are related to the probability of incurring sharp reversals in capital inflows controlling for global push factors. In particular, negative growth shocks combined with high levels of leverage in the domestic private sector are significantly correlated with sudden stops. This is in line with real business cycle models including an occasionally binding credit constraint and income trend shocks.

Constructing a House Price Index for Saudi Arabia

House price movements have a significant influence on the economy. These movements can dramatically affect household wealth and shift consumer spending. Unfortunately, the house price index development in Saudi Arabia is fragile, and data quality suffers from severe errors due to administrative negligence. Therefore, the k-means clustering algorithm technique was used to correct these errors and appropriately redefine the property type. This study attempts to overcome these severe errors to improve transparency and support literature in the Saudi Arabian real estate market as well as the Middle East and North African real estate markets. I compared the official real estate price index of the General Authority for Statistics GASTAT with the proposed mix adjustment and repeat-sales index I constructed from the same transaction data. I conclude that there are considerable concerns regarding the GASTAT index’s credibility and accuracy. This study is the first attempt to construct sophisticated indices for Saudi Arabia on citywide and national levels. I also provide stratification and repeat sales indices for Saudi Arabia. They illustrate the real estate business cycle for the first time and adequately measure the pure house price movements in Saudi Arabia.

Labor market volatility in a fully specified RBC search model: An analytical investigation

I show that including a nonlinear production function with physical capital in the Diamond–Mortensen–Pissarides model lowers the elasticity of labor market tightness with respect to labor productivity by about 11.5% under the Hagedorn–Manovskii’s calibration. My finding is robust against different calibration techniques, as well as against different variants of real business cycle models with search-and-matching frictions. While the recent macroeconomics-labor literature focuses on the fundamental surplus to solve the Shimer puzzle, my analysis highlights the existence of an additional channel through which the nonlinearities implied by a production function with physical capital affect labor market volatility.

The economic and environmental effects of an optimal emission reduction subsidy policy in the presence of business cycles

PurposeAs a by-product of the production process, emissions can follow output fluctuations. Hence, disregarding the relationship between economic fluctuations and emissions could result in undesirable environmental outcomes. This study aims to investigate the environmental and economic effects of abatement subsidies on overall emissions during business cycles in Australia.Design/methodology/approachA real business cycle (RBC) model is devised and parameterised in this paper. RBC models have been recently introduced to environmental policy analysis, and this study contributes to the literature by investigating the effects of a potential subsidy policy in an RBC framework. The model is also calibrated and provides solutions for the Australian economy.FindingsThe authors find that under a steady-state situation, supporting abatement can result in reducing emissions by 6.45% while it imposes welfare costs to the economy (by 0.61%). Simulation results show that an optimal abatement policy should be pro-cyclical, with the abatement subsidy increasing during expansions and decreasing during recessions. As well, in a subsidy policy setting, emissions would react pro-cyclically, i.e. emissions increase (decrease) when the gross domestic product increases (decreases). The abatement reaction by firms, however, is different, because when a positive productivity shock occurs, firms reduce abatement and allocate resources to production. Nonetheless, as time passes, the increased subsidy provides a strong enough incentive to allocate resources to abatement and, subsequently, abatement increases.Originality/valueThis paper investigates how an emission reduction subsidy should be adapted to macroeconomic fluctuations so that it can limit variations in emissions.