[PPT] - Ricardo Mourinho Flix Economics and Researach Department Banco de PowerPoint Presentation

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DSGE Modelling at the Banco de Portugal

Ricardo Mourinho Félix Economics and Researach Department Banco de Portugal

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DSGE modelling at the Banco de Portugal

Ricardo Mourinho F´ elix

Economics and Research Department, Banco de Portugal

IMF Macro Modelling Workshop Washington, DC January 6-9, 2009

R. F´

elix (BdP) IMF Workshop 1 / 47

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Outline

1 DSGE models at the Banco de Portugal 2 Introducing and calibrating PESSOA

Households and labour unions Firms Government Rest of the world and market clearing Calibration

3 Increasing competition in the domestic markets

Motivation of the paper Simulation design and results Main findings

4 Ongoing research using PESSOA 5 Directions for further research

R. F´

elix (BdP) IMF Workshop 2 / 47

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DSGE models at the Banco de Portugal

DSGE modelling activities started in 2005 Available DSGE models EA-US model Alves, N., S. Gomes and J. Sousa (2007) PESSOA model Almeida, V., G. Castro and R. F´ elix (2008) Ongoing DSGE research projects Available models are being used in applied research EAGLE model: joint project with ECB and Banca d’Italia Identification issues in DSGE models Credit frictions in DGSE models

R. F´

elix (BdP) IMF Workshop 3 / 47

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Introducing and calibrating PESSOA

Introducing PESSOA PESSOA

Portuguese Economy Structural Small Open economy Analytical model

Almeida, Vanda, Gabriela Castro and Ricardo Mourinho F´ elix (2008) “Improving competition in the non-tradables goods and labour market” WP 16/2008, Banco de Portugal

R. F´

elix (BdP) IMF Workshop 4 / 47

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Introducing and calibrating PESSOA

Introducing PESSOA: the model

Figure 1: Model flowchart

Tradable goods manufacturers Non-tradable goods manufacturers Consummer goods retailers Investment goods retailers

Governm. consump.

goods retailers Export goods retailers Households Labour unions Foreign suppliers Foreign costumers Government

R. F´

elix (BdP) IMF Workshop 5 / 47

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Introducing and calibrating PESSOA

Introducing PESSOA: the model

General features SOE integrated in a monetary union (=euro area) 6 types of agents:

Households Labour unions Manufacturers (intermediate goods producers) Distributors (final goods producers) Government Rest of the world (=euro area⇒ S = 1)

Labour and product differentiation Competition: monopolistic in output markets, perfect in input markets Real and nominal rigidities (quadratic adjustment costs)

R. F´

elix (BdP) IMF Workshop 6 / 47

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Introducing and calibrating PESSOA

Introducing PESSOA: the model

PESSOA is largely inspired on GIMF (Kumhof, M. and M. Laxton (2007)) PESSOA Small-open economy model Exogenous monetary policy No role for public investment Trade in semi-finished goods Heterogeneous import contents GIMF Multi-country model Endogenous monetary policy Public investment plays a role Trade in intermediate and final goods Homogeneous import content

R. F´

elix (BdP) IMF Workshop 7 / 47

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Introducing and calibrating PESSOA Households and labour unions

Households (I)

General features Blanchard-Yaari overlapping generations, declining lifetime productivity Liquidity constrained and liquidity unconstrained (H ∈ {LIQ, OLG}) Consume goods from distributors, supply labour to a union Pay taxes on consumption and labour income, receive transfers External habit persistence OLGs’ specific features Own firms Hold domestic and foreign bonds

R. F´

elix (BdP) IMF Workshop 8 / 47

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Introducing and calibrating PESSOA Households and labour unions

Households (II)

CRRA utility

UH

a,t(h) =

1 1 − γ  

CH

a,t(h)

HabH

a,t

ηH (1 − LH

a,t(h))1−ηH

 

1−γ

Budget constraints

OLG: PtCOLG

a,t

(h) + Ba,t(h) + B∗

a,t(h) = (1 − τL,t)WtΦaLOLG a,t

(h) + TansfersOLG

a,t

(h)+ + 1 θ

it−1Ba−1,t−1(h) + i∗

t−1B∗ a−1,t−1(h)

+ Dividendsa,t(h)

LIQ: PtCLIQ

a,t

(h) = (1 − τL,t)WtΦaLLIQ

a,t (h) + TransfersLIQ a,t (h)

where Pt = P C

t (1 + τC,t) is the numeraire.

R. F´

elix (BdP) IMF Workshop 9 / 47

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Introducing and calibrating PESSOA Households and labour unions

Households (III)

Utility maximisation problems

OLG: max

COLG

a,t

(h),LOLG

a,t

(h),Ba,t(h),B∗

a,t(h)

Et

∞

s=0

(βθ)s UOLG

a,t+s(h)

s.t. Intertemporal budget constraint OLGt LIQ: max

CLIQ

a,t

(h),LLIQ

a,t

(h)

Et

∞

s=0

(βθ)s ULIQ

a,t+s(h)

s.t. Intratemporal budget constraint LIQt

Wealth

hwt + fwt = human wealth+financial wealth ˜ Rt+s = Πs

l=1θ/it+l−1

human wealth discount factor

R. F´

elix (BdP) IMF Workshop 10 / 47

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Introducing and calibrating PESSOA Households and labour unions

Labour unions

General features Hire labour from households, rent it to manufacturers charging a markup Pay tax on “dividend” arising from monopolistic competition Quadratic wage growth adjustment costs Dividend

DU

t (h) =

1 − τL,t
[(Vt(h) − Wt) Ut(h) − Adj.costst(h)]

Dividend maximisation problem

max

Vt(h)

Et

∞

s=0

˜ Rt+sDU

t+s(h)

s.t. Adj.costs, Type h labour demand

R. F´

elix (BdP) IMF Workshop 11 / 47

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Introducing and calibrating PESSOA Firms

Manufacturers (I)

General features Produce tradable and non-tradable goods (J ∈ {T, N}), using labour from unions and capital (formed with investment good from distributors) Pay social security contributions on wage bill, tax on dividends Quadratic price growth and investment adjustment costs Production function

ZJ

t (j) =

(1 − αJ

U)

1 ξZJ

KJ

t (j)

ξZJ −1

ξZJ

+ (αJ

U)

1 ξZJ

TtAJ

t UJ t (j)

ξZJ −1

ξZJ

ξZJ

ξZJ −1

Capital accumulation equation

KJ

t+1(j) = (1 − δJ)KJ t (j) + IJ t (j)

R. F´

elix (BdP) IMF Workshop 12 / 47

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Introducing and calibrating PESSOA Firms

Manufacturers (II)

Dividend

DJ

t (j) =

P J

t (j)ZJ t (j) − (1 + τSP,t)VtUJ t (j) − P I t IJ t (j) − (Fix.+Adj.costs)J t (j)

−

− τK,t

P J

t (j)ZJ t (j) − (1 + τSP,t)VtUJ t (j) − P I t

qJ

t δJKJ t (j)

− (Fix.+Adj.costs)J

t (j)

Dividend maximisation problem

max

P J

t (j),IJ t (j),UJ t (j),KJ t+1(j)

Et

∞

s=0

˜ Rt+sDJ

t+s(j)

s.t. Cap.accum.equation, Prod.function, Adj.costs, Type j intermediate good demand

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elix (BdP) IMF Workshop 13 / 47

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Introducing and calibrating PESSOA Firms

Distributors (I): General features

Two-stage production technology 1st stage Produce composite tradable good using domestic tradables and imported goods Quadratic import content adjustment costs 2nd stage Produce private and government consumption, investment and export goods (F ∈ {C, I, G, X}) using tradable good produced in 1st stage and non-tradable goods from domestic manufacturers Pay tax on profits Quadratic price growth adjustment costs

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elix (BdP) IMF Workshop 14 / 47

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Introducing and calibrating PESSOA Firms

Distributors (II): 1st stage

Production function

Y AF t (f) =   (αAF ) 1 ξAF

ZT F

t (f) ξAF −1 ξAF + (1 − αAF ) 1 ξAF

MF

t (f)

1 − ΓAF

t (f) ξAF −1 ξAF    ξAF ξAF −1

Cost

CF

t (f) = P T t ZT F t

(f) + P ∗

t MF t (f)

Cost minimisation problem

min

ZT F

t

(f),MF

t (f)

CF

t (f)

s.t. Prod.function, Adj.costs

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elix (BdP) IMF Workshop 15 / 47

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Introducing and calibrating PESSOA Firms

Distributors (III): 2nd stage

Production function

Y F

t (f) =

(1 − αF )

1 ξF

Y AF

t

(f) ξF −1

ξF

+ (αF )

1 ξF

ZNF

t

(f) ξF −1

ξF

ξF

ξF −1

Dividend

DF

t (f) = (1 − τD,t)

P F

t (f)Y F t (f) − ΛAF t

(f)Y AF

t

(f) − P N

t ZNF t

(f) − (Fix.+Adj.costs)F

t (f)

Dividend maximisation problem

max

P F

t (f),Y AF t

(f),ZNF

t

(f)

Et

∞

s=0

˜ Rt+sDF

t+s(f)

s.t. Prod.function, Adj.costs, Type f final good demand

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elix (BdP) IMF Workshop 16 / 47

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Introducing and calibrating PESSOA Government

Government

General features Collects taxes, pay/receives transfers, consumes, issues debt Budget constraint

SGt = Taxest − P G

t Gt + NetTransfersG t

Bt = Bt−1 − SGt − (it−1 − 1) Bt−1

Structural budget balance fiscal rule

SG

GDP

t

=

SG

GDP tar

t

+ dtax RVt − RV ss

t

GDP ss

t

+ ddebt
Bt

GDP ss

t

−

B

GDP tar

t

Labour income tax rate is set endogenously
R. F´

elix (BdP) IMF Workshop 17 / 47

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Introducing and calibrating PESSOA Rest of the world and market clearing

Rest of the world and market clearing

Rest of the world = euro area Trade linkages: sells goods to distributors, buys export goods from distributors Financial linkages: households sell/buy bonds in the RoW Market clearing

H

LH

t

=

J

U J

t

ZJ

t =

F

ZJF

t

+ Fix.+Adj.costst Y C

t

=

H

CH

t

+ Fix.+Adj.costst; Y I

t =

J

IJ

t + Fix.+Adj.costst

Y G

t

= Gt + Fix.+Adj.costst; Y X

t

= Xt + Fix.+Adj.costst B∗

t = it−1B∗ t−1 + P X t Xt − P ∗ t Mt + NetTransfers∗ t

R. F´

elix (BdP) IMF Workshop 18 / 47

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Introducing and calibrating PESSOA Calibration

Calibration

Productivity growth, inflation rate, interest rate: euro area DSGE models Steady-state key ratios: National Accounts data, 1995-2006 Structural parameters: DSGE literature Nominal and real rigidities: Parameters from the literature as initial guesses

R. F´

elix (BdP) IMF Workshop 19 / 47

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Increasing competition in the domestic markets Motivation of the paper

Increasing competition in the domestic markets: motivation

The Portuguese economy: 90’s versus 2000’s 90’s A case of success in the European integration process 2000’s Slowdown in economic activity, real divergence vs. euro area What is behind this ? Most popular stories are: FDI was diverted to Eastern European countries Integration of emerging economies with low unit labour costs It can be disputed: FDI: E(rK) > cost of capital Non-competitive Portuguese companies were displaced

R. F´

elix (BdP) IMF Workshop 20 / 47

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Increasing competition in the domestic markets Motivation of the paper

Increasing competition in the domestic markets: motivation

How to restore competitiveness in the new international environment ? Increasing competition in domestic markets fosters international competitiveness Improves resource allocation Reduces non-tradable costs (knock-on effects) Crucial for a sound business environment (FDI inflows) Faster adjustment to shocks Portugal has still margin to improve competition

References: OECD, EC; Aghion; Høj, Conway, Nicoletti; Laxton and Bayoumi; Blanchard and Giavazzi

R. F´

elix (BdP) IMF Workshop 21 / 47

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Increasing competition in the domestic markets Motivation of the paper

Increasing competition in the domestic markets: motivation

How to restore competitiveness in the new international environment ?

Figure 2: Regulation stance in Portugal

Source: OECD, Product Market Regulation Indicators Source: OECD, Employment Protection Legislation Indicators

Employment Protection Legislation Product Market Regulation

0 less restrictive; 4 most restrictive 0 less restrictive; 4 most restrictive 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 US UK CA NZ IE AU SW SK HU JP DK CZ KO FI PL AT NL IT DE BE NW SE FR GR ES MX PT TU 1998 2003 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 AU UK IC US IE DK NZ CA SE LU JP FI BE NL AT SK DE N KO PT ES S FR CZ GR IT HU MX TU PL 1998 2003

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elix (BdP) IMF Workshop 22 / 47

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Increasing competition in the domestic markets Simulation design and results

Simulation design

Features Permanent shocks to non-tradables price and wage markups Perfect foresight/information Design Non-tradable : Decline of 2 pp. in price markup (from 20% to 18%) Wage : Decline of 2.5 pp. in wage markup (from 25% to 22.5%) Pass-through : 80 % of the decline achieved in 2 years

R. F´

elix (BdP) IMF Workshop 23 / 47

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Increasing competition in the domestic markets Simulation design and results

The impact of increasing competition in non-tradables

Table 1: LR impact

NT GDP 1.3 Consumption 1.9 GFCF 2.1 Exports 1.5 Imports 0.3 Human wealth 1.2 Real wage (firms) 0.5 Labour inc. tax (pp.)

2.0

NFA ( % GDP) 4.7 Real exch. rate (+ depr.) 1.5 Domestic ToT (+ depr.) 1.7 Price tradables 0.3 Price non-tradables

1.4

Tradables output 2.0 Non-tradables output 1.4 Tradables hours 1.7 Non-tradables hours 1.2 Source: Own calculations

1 Real exchange rate depreciation

(pN ⇓, pT ↑) ⇒ λF ↓⇒ (pX ↓, ǫ ↑)

2 Higher demand for domestic

intermediates and final goods (pX ↓, ǫ ↑) ⇒ X ↑ ǫ ↑⇒ (ZT F ⇑, M F ↑)

3 Increase in the capital intensity of

utput

(pI/v) ↓⇒ (K/L) ↑

4 Households’ consumption increases

(w ↑, τL ↓) ⇒ hw ↑; fw ↑⇒ C ↑

R. F´

elix (BdP) IMF Workshop 24 / 47

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Increasing competition in the domestic markets Simulation design and results

The impact of increasing competition in labour market

Table 2: LR impact

NT W All GDP 1.3 1.2 2.5 Consumption 1.9 1.7 3.5 GFCF 2.1 0.8 2.9 Exports 1.5 1.1 2.5 Imports 0.3 0.3 0.6 Human wealth 1.2 1.2 2.3 Real wage (firms) 0.5

0.6

0.0 Labour inc. tax (pp.)

2.0
1.2
3.2

NFA ( % GDP) 4.7 4.5 9.2 Real exch. rate (+ depr.) 1.5 0.8 2.2 Domestic ToT (+ depr.) 1.7 0.0 1.7 Price tradables 0.3

0.3

0.0 Price non-tradables

1.4
0.3
1.7

Tradables output 2.0 1.7 3.7 Non-tradables output 1.4 0.8 2.2 Tradables hours 1.7 2.0 3.7 Non-tradables hours 1.2 1.1 2.2 Source: Own calculations

1 Real exchange rate depreciation

(pN, pT ) ↓⇒ λF ↓⇒ (pX ↓, ǫ ↑)

2 Higher demand for domestic

intermediates and final goods (pX ↓, ǫ ↑) ⇒ X ↑ ǫ ↑⇒ (ZT F ↑> M F ↑)

3 Higher labour intensity

(v/pI) ↓⇒ (K/L) ↓

4 Households’ consumption

increases DU ↓< (w ↑, τL ↓) ⇒ hw ↑ ; fw ↑⇒ C ↑

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elix (BdP) IMF Workshop 25 / 47

SLIDE 28

Increasing competition in the domestic markets Simulation design and results

Implementation issue: SR negative impact on consumption

Figure 3: SR impact

1.5
1.0
0.5

0.0 0.5 1.0 1.5 2.0 2.5 3.0 1 2 3 4 5 6 7 8 9 10

Cons. H.Wealth Hours

1.5
1.0
0.5

0.0 0.5 1.0 1.5 1 2 3 4 5 6 7 8 9 10

Inflation Real interest rate

1 Real interest rate increases temporarily

(π ↓;¯ i) ⇒ r ↑

2 Households’ consumption declines

r ↑⇒ hw ↓⇒ C ↓

3 Higher demand, hours increase

π ↓⇒ ǫ ↑⇒ Y ↑⇒ L ↑

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elix (BdP) IMF Workshop 26 / 47

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Increasing competition in the domestic markets Main findings

The impact of increasing competition: main findings

Increasing competition in domestic markets promotes the real exchange rate adjustment of the Portuguese economy within the EMU A cut in non-tradable goods prices and wage markups improves international competitiveness and boost economic activity Practical implementation issue: short-run negative impact in consumption and leisure Estimated impacts are on the downside: fiercer competition induces productivity gains not considered

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elix (BdP) IMF Workshop 27 / 47

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Ongoing research using PESSOA

The Portuguese economy in the EMU: a story of shocks and frictions (ongoing research!)

Aim of the study Assess the performance of the Portuguese economy in the EMU through the lens of a DSGE model and draw some policy implications (if there are some!) Structure of the article Empirical evidence and identification of some stylised facts Main shocks and the role of frictions

S1 Total factor productivity slowdown S2 The fiscal policy imbalance and the fiscal consolidation S3 The aftermath of the sharp interest rate decline S4 Fiercer competition in international goods markets S5 Still low competition in domestic markets

Policy implications (hopefully some will arise!)

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elix (BdP) IMF Workshop 28 / 47

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Directions for further research

Extend the calibrated version of the model to include

Macro-financial linkages The role of commodities, in particular oil Search and matching frictions in the labour market

Estimate a stripped down version of the model using Bayesian techniques Phase-in the model in regular projection and simulation activities

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elix (BdP) IMF Workshop 29 / 47

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DSGE modelling at the Banco de Portugal

Ricardo Mourinho F´ elix

Economics and Research Department, Banco de Portugal

IMF Macro Modelling Workshop Washington, DC January 6-9, 2009

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elix (BdP) IMF Workshop 30 / 47

SLIDE 33

Appendix

The regulatory stance in Portugal (A1)

Figure 4: PMR indicators

Product market regulation 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 AU UK IC US IE DK NZ CA SE LU JP FI BE NL AT SK DE N KO PT ES S FR CZ GR IT HU MX TU PL 1998 2003 State control 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 AU IC US DK SK NZ JP CA KO UK MX SE NL AT IE LU DE SW FI BE CZ FR ES PT NW GR TU IT HU PL 1998 2003 Barriers to entrepreneurship 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 UK CA IE N SE FI AU NZ US SK LU DK PT IT JP HU DE IC GR ES FR BE AT NL KO S CZ MX PL TU 1998 2003 Barriers to trade and investment 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 IC BE UK IE FI DE NL ES AT LU US NW SE PT DK NZ AU CZ JP FR SW CA IT GR KO HU SK TU MX PL 1998 2003

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elix (BdP) IMF Workshop 31 / 47

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Appendix

The regulatory stance in Portugal (A2)

Figure 5: EPL indicators

Collective dismissals 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 NZ JP KO CZ FR IE TU FI AU CA HU N UK US NL ES AT GR PT DE MX SK DK S BE PL SE IT 1998 2003 Employment protection legislation 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 US UK CA NZ IE AU SW SK HU JP DK CZ KO FI PL AT NL IT DE BE NW SE FR GR ES MX PT TU 1998 2003 Regular employment: difficulty of dismissal 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 US UK DK S BE AU IE CA PL TU HU NZ FI SK FR KO GR DE IT NL ES JP MX AT CZ N PT SE 1998 2003 Regular employment: notice and severance pay for no-fault individual dismissals 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 5.5 US NZ IT IE AT KO CA AU FI N UK DE PL S SE HU JP DK FR NL MX GR BE ES CZ SK TU PT 1998 2003

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elix (BdP) IMF Workshop 32 / 47

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Appendix

The regulatory stance in Portugal (A3)

Figure 6: Weight of administered prices in HICP

5 10 15 20 25 30 Ireland Malta Finland Cyprus Spain Italy Estonia Luxembourg Austria Latvia France Greece Netherlands Sweden Euro area Slovenia United Kingdom Lithuania Denmark Portugal Germany Belgium Slovakia Hungary Poland Bulgaria Czech Republic Romania Services Goods

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elix (BdP) IMF Workshop 33 / 47

SLIDE 36

Appendix

Introducing PESSOA

Figure 7: Model flowchart

Tradable goods manufacturers Non-tradable goods manufacturers Consummer goods retailers Investment goods retailers

Governm. consump.

goods retailers Export goods retailers Households Labour unions Foreign suppliers Foreign costumers Government

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elix (BdP) IMF Workshop 34 / 47

SLIDE 37

Appendix

Households

Figure 8: The households’ flowchart

Government Labour unions Rest of the world Manufacturers Retailers (C,G,I,X) OLG households LIQ households DT,DN i*B*ε DC,DG, DI,DX COLG CLIQ LOLG LLIQ W W DU τL iB τL τΤ

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elix (BdP) IMF Workshop 35 / 47

SLIDE 38

Appendix

Firms

Figure 9: The firms’ flowchart

ZN

CES(KT,LT)

LN LT KN KT ZT

CES(KT,LT)

Retailers

YAC

CES(ZTC,MC)

YC

CES(YAC,ZNC)

YAI

CES(ZTI,MI)

YI

CES(YAI,ZNI)

YAC

CES(ZTX,MX)

YX

CES(YAX,ZNX)

YAG

CES(ZTG,MG)

YG

CES(YAG,ZNG)

M=MC+MI+MX+MG

Manufacturers Domestic primary inputs Rest of the world inputs

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elix (BdP) IMF Workshop 36 / 47

SLIDE 39

Appendix

OLG households

Optimal aggregate conditions

COLG

t

n(1 − ψ) − LOLG

t

=

ηOLG

1 − ηOLG

(1 − τL,t)wt

it = i∗

t

COLG

t

= mpct

hwL

t + hwK t + fwt

hwL

t = n(1 − ψ)wt(1 − τL,t) + θχ

rt hwL

t+1

hwK

t

= (1 − ι)

dN

t + dT t + dC t + dG t + dI t + dX t

+ (1 − ψ)
dU

t + trgt + trxt

+ θ

rt hwK

t+1

fwt = rt−1

bt−1 + b∗

t−1 · ǫt−1

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elix (BdP) IMF Workshop 37 / 47

SLIDE 40

Appendix

Labour unions

The equilibrium condition: a wage Phillips curve

σU,t σU,t − 1 wt − vt = = φUTt σU,t − 1

πV

t

πV

t−1

− 1

πV

t

πV

t−1

− 1 − τL,t+1 1 − τL,t θ rt Ut+1Tt+1 Ut φU σU,t − 1

πV

t+1

πV

t

− 1

πV

t+1

πV

t

in steady-state: v = σU σU − 1 w

R. F´

elix (BdP) IMF Workshop 38 / 47

SLIDE 41

Appendix

Manufacturers

The equilibrium conditions: a Phillips curve

σJ,t σJ,t − 1 λJ

t

pJ

t

− 1 = φP J σJ,t − 1

πJ

t

πJ

t−1

− 1

πJ

t

πJ

t−1

− 1 − τK,t+1 1 − τK,t θ rt φP J σJ,t − 1 pJ

t+1

pJ

t

ZJ

t+1

ZJ

t

πJ

t+1

πJ

t

− 1

πJ

t+1

πJ

t

in steady-state: pJ = σJ σJ − 1 λJ

R. F´

elix (BdP) IMF Workshop 39 / 47

SLIDE 42

Appendix

Manufacturers

The equilibrium conditions: desired capital stock level

qJ

t = θ

rt πI

t+1

πt+1

qJ

t+1

1 − δJ

+ rJ

K,t+1

pI

t+1

− τK,t+1

rJ

K,t+1

pI

t+1

− qJ

t+1δJ

+ (1 − τK,t+1) θ

rt πI

t+1

πt+1 IJ

t+1

KJ

t+1

φJ

K

IJ

t+1

KJ

t+1

− IJ KJ

+ φJ

I

IJ

t+1

KJ

t+1

− IJ

t

KJ

t

− (1 − τK,t+1) θ

rt πI

t+1

πt+1   φJ

K

2

IJ

t+1

KJ

t+1

− IJ KJ 2 + φJ

I

2

IJ

t+1

KJ

t+1

− IJ

t

KJ

t

2  In steady-state, after-tax real return on capital equals the certain equivalent real return of government bonds. r θ = 1 + (1 − τk)

rJ

K

pI − δJ

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Appendix

Manufacturers

The equilibrium conditions: optimal investment path Investment path condition depends on investment adjustment cost parameters.

qJ

t = 1 +

1 − τK,t
φJ

K

IJ

t

KJ

t

− IJ KJ

+ φJ

I

IJ

t

KJ

t

− IJ

t−1

KJ

t−1

In steady-state, Tobin’s-Q equals unity, market value of installed capital equals replacement

cost.

The equilibrium conditions: optimal labour demand

1 + τSP,t
vt = λJ

t

ZJ

t αJ U

TtAJ

t UJ t

1

ξZJ

TtAJ

t

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Appendix

Calibration: steady-state key ratios

Table 3: Steady-state key ratios

Data Model Expenditure (as a % of GDP) Private consumption 0.64 0.61 Government consumption and GFCF 0.22 0.21 Private investment 0.21 0.21 Exports 0.29 0.29 Imports 0.37 0.33 Labour income share (as a % of overall income) 0.57 0.56 Tradable goods 0.54 0.54 Non-tradable goods 0.58 0.58 Capital-output ratio (as a % of output) NA 2.34 Tradable goods NA 2.53 Non-tradable goods NA 2.21 Government (as a % of GDP) Debt stock 0.57 0.53 Fiscal balance

0.07
0.02

Overall revenues 0.38 0.39 Overall expenditure 0.45 0.41 External account (as a % of GDP) Net foreign assets

0.60
0.60

Current account

0.06
0.02

Trade balance

0.08
0.04
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Appendix

Calibration: households and labour union parameters

Table 4: Households parameters

Households discount rate (annualised) β 0.97 Intertemporal elasticity of substitution 1 γ 0.20 OLG households instant probability of death (annualised) 1 − θ 0.04 OLG households habit persistence ν 0.70 Consumption share - OLG households ηOLG 0.74 Consumption share - LIQ households ηLIQ 0.70 Lifetime productivity decline rate (annualised) 1 − χ 0.04 Share of LIQ households ψ 0.40 Share of dividend transfers from OLG to LIQ households ι 0.20 Memo items: Marginal propensity to consume wealth 0.05 Average planning horizon (years) 25 Average worklife (years) 25

Table 5: Labour union parameters

Wage mark-up σU σU −1 1.25 Wage rigidity - Adjustment cost φU 200 Memo items: Duration wage contracts (quarters) 6.4

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Appendix

Calibration: manufacturers parameters

Table 6: Manufacturers parameters

Tradable Non-tradable J = T J = N Depreciation rate (annualised) δ 0.09 0.09 Labour augmenting prod. growth (annualised) g 1.02 1.02 EoS between capital and labour ξJ 0.99 0.99 Quasi labour income share αJ 0.60 0.60 Price markup σJ σJ −1 1.10 1.20 Capital adjustment cost φKJ 50 50 Investment adjustment cost φIJ 100 100 Price adjustment cost φP J 200 200 Memo items: Duration price contracts (quarters) 3.9 5.7

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Appendix

Calibration: markups

Figure 10: Markups and PMR indicator

Tradables Non-tradables

y = 0.0114x + 0.1058 0% 5% 10% 15% 20% 25% 30% 35% 40% 1.0 1.5 2.0 2.5 3.0 PMR indicator Markup y = 0.0996x + 0.0593 0% 5% 10% 15% 20% 25% 30% 35% 40% 1.0 1.5 2.0 2.5 3.0 PMR indicator Markup

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Appendix

Calibration: distributors parameters

Table 7: Distributors parameters

Consumer Govt. Invest. Export F = C F = G F = I F = X EoS domestic tradable/imported good ξAF 1.50 1.50 1.50 1.50 Assembled good quasi domestic content αAF 0.12 0.02 0.02 0.19 EoS assembled/non-tradable good ξF 0.50 0.50 0.50 0.50 Non-tradable good (quasi) factor share αF 0.71 0.98 0.88 0.15 Price markup σF σF −1 1.05 1.05 1.05 1.03 Import content adjustment cost φAF 2 2 2 2 Price adjustment cost φP F 200 200 200 200 Memo items: Implied import content 0.29 0.10 0.40 0.30 Implied non-tradable content 0.38 0.88 0.53 0.05 Duration price contracts (quarters) 2.7 2.7 2.7 1.8

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Appendix

Calibration: government and foreign economy parameters

Table 8: Government parameters

Labour income tax rate τL 0.29 Consumption tax rate τC 0.30 Capital income tax rate τK 0.17 Employers social security contribution rate τSP 0.19 Debt to GDP ratio (annualised) b gdp 0.53 Speed adjustment towards the target debt ratio parameter ddebt 0.10

Table 9: Foreign economy parameters

Foreign interest rate (annualised) i∗ 1.05 Foreign inflation (annualised) π∗ 1.02 EoS between domestic and imported goods ξ∗ 1.50

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