2023. Working papers
Patrick Grüning, Zeynep Kantur
The most effective approach to tackling climate change is by decarbonising produc- tion processes. However, decarbonisation might render assets stranded, impacting not only the relevant sector but also causing a ripple effect across all sectors, thereby potentially destabilising macroeconomic stability. We develop a multi-sector New Keynesian model with two physical capital types (brown and green) and input- output linkages to examine the economic impact of sector-specific capital stranding. Stranded brown capital in the brown sector yields a relocation of economic ac- tivities to the green sector and thus environmental benefits with small aggregate consequences, while brown capital stranding in both sectors implies larger economic costs and smaller environmental benefits. Brown consumption taxes and green pro- ductivity shocks facilitate the green transition, while brown investment taxes or green investment subsidies turn out to be less favourable policies in this respect. However, a combination of these two investment policies yields favourable economic and environmental outcomes. Doubling the carbon tax in the brown sector yields significant relocation activities at relatively small economic costs. If the central bank responds strongly to short-run inflationary pressures of carbon tax increases, this leads to larger output losses in the short run and higher output gains in the long run.
Keywords: capital utilization, stranded assets, production network, climate change, fiscal policy, monetary policy
JEL codes: E22, E32, E52, E61, L14
Andrejs Zlobins
Portfolio rebalancing is a key mechanism through which central bank asset purchases flatten the yield curve, thus providing additional monetary policy accommodation when conventional policy rate setting is constrained by the effective lower bound. Existing literature provides ample evidence that this channel has played a major role in compressing the long-term interest rates and provided a broad-based easing of financial conditions for firms and households in the euro area. However, this evidence originates from either aggregate euro area or its largest jurisdic- tions, leaving the effects of the Eurosystem’s asset purchases on smaller member states, such as Latvia, unclear. Therefore, we employ a bilateral structural vector autoregression, featuring both aggregate euro area and Latvian blocks, as well as a panel structural vector autoregression with cross-sectional heterogeneity to obtain evidence from both macro-level and bank-level data in order to shed some light on the transmission of QE to the Latvian economy. Our findings suggest that QE led to a compression of sovereign borrowing costs in Latvia and boosted economic ac- tivity and prices. At the same time, we also document that the further pass-through to domestic financial conditions was weak owing to limited asset rebalancing by the domestic banking sector in response to the Eurosystem’s QE. Instead, we show that Latvian yields were compressed due to direct intervention of the central bank in the bond markets and portfolio readjustment of foreign investors. Our study thus provides additional evidence that the transmission of common monetary policy to the Latvian economy is impaired via the domestic banking sector.
Keywords: quantitative easing, portfolio rebalancing, monetary policy, euro area, Latvia
JEL Codes: C54, E50, E52, E58
Karsten Staehr, Oļegs Tkačevs, Katri Urke
This paper estimates fiscal reaction functions to examine the importance of inflation and inflation sur- prises for fiscal outcomes in the euro area countries, covering the first 12 countries to join the euro area. The effect of HICP inflation on the primary fiscal balance in per cent of GDP is positive, and statistically and economically significant. The positive effect stems from both the revenue side, particularly direct taxes and indirect taxes, and the expenditure side, particularly primary current expenditures. The effects of HICP inflation on the primary balance and other fiscal outcomes appear in large part to stem from inflation surprises, which are errors in the inflation forecasts available for preparing budgets. The positive effect on the primary fiscal balance does not exhibit noticeable non-linearities.
Keywords: Public finances; Fiscal outcome; Inflation; Inflation surprises
JEL Codes: H6, H62, H68, E31
Konstantīns Beņkovskis, Oļegs Tkačevs and Kārlis Vilerts
This paper studies the employment effect of the job retention scheme implemented during the Covid-19 pandemic. Using firm-level data from Latvia, we investigate whether a change in the number of employees in firms that received support from the job retention programme has been different from that of similar firms which did not receive such support, and whether these differ- ences have disappeared over time. We find strong evidence that job retention scheme participants in Latvia were less likely to cut employment and that this effect persisted for several months after receiving support. Participation in the job retention scheme affected both the likelihood of a firm’s survival and the rate at which employees were laid off. Our results also suggest that the participation effect was not uniform across firms, with the effect being less pronounced in service sectors with a higher level of contact intensity and more pronounced in sectors with a higher proportion of highly skilled employees.
Keywords: Job retention schemes, idle-time allowance, Covid-19, employment
JEL Codes: E24, H12, J62, J68
Konstantīns Beņkovskis, Oļegs Matvejevs
This paper describes the new version of Latvian CGE model, which is now an integral part of the joint CGE-EUROMOD modelling system. Special attention is devoted to the labour market and consumption blocks of CGE that are substantially improved compared with the previous version. We briefly describe the motivation to link Latvian CGE with Latvian EUROMOD and provide major technical details. We also provide an example of the policy simulation by the joint CGE-EUROMOD system, demonstrating how the introduction of the progressive personal income tax rate affected the Latvian economy at macro, industry and micro level.
Keywords: CGE model, Latvia, labour market, consumption, EUROMOD
JEL codes: D58, C68, H2, H6, D9
Konstantins Beņkovskis, Ludmila Fadejeva, Anna Pluta, Anna Zasova
In this paper, we link a CGE model with the tax-benefit microsimulation model EUROMOD for Latvia. The model linkage is done using an iterative top-down bottom-up approach, ensuring the convergence of changes in disposable income, employment and wage in both models. We also incorporate the unreported wage payments in CGE and EUROMOD to account for the substantial labour tax non-compliance in Latvia and improve the modelling of the fiscal sector.
Several simulations demonstrate the advantages of the joint CGE-EUROMOD system over the individual macro and microsimulation models. The lack of income distribution aspect and the scarcity of fiscal instruments in CGE can be overcome by the features of EUROMOD. The CGE model, on the other hand, provides macroeconomic spillovers that are missing in the simulations of EUROMOD.
Keywords: EUROMOD, CGE model, model linkage, informal sector
JEL codes: C68, D58, D90, J46