Publications

We study the welfare implications of distortions, such as markups and returns to scale, when firm entry is slow to adjust, allowing quasi-rents to persist for longer. First, we present evidence on differences in speed of firm entry adjustment across US industries. In some industries, such as hospitality, firms respond rapidly to profit opportunities, arbitraging quasi-rent quickly. Whereas, in other industries, such as construction, entrants respond slowly, sustaining incumbents’ quasi-rents for longer. We develop a model of sluggish firm adjustment, which shows that the sluggishness of firm adjustment magnifies the welfare costs of distortions. We study a model with a fixed cost and increasing marginal cost such that a perfectly competitive equilibrium exists, and in the absence of distortions market and planner equilibrium coincide with firms operating at minimum efficient scale. We contrast outcomes when there is curvature on the demand-side of the economy from markups and curvature on the supply-side of the economy from returns to scale, adding counter-evidence to the perception that the setups are isomorphic.

Keywords: Markups, Firm Entry, Returns to Scale, Welfare

JEL codes: E32, D21, D43, L13, C62

This paper introduces the Systemic Risk Modelling System (SRMS), a new macroprudential stress testing model for the Lithuanian banking sector. The SRMS addresses the limitations of traditional static models by incorporating dynamic balance sheet assumptions and capturing second-round effects, providing a more comprehensive assessment of systemic risks. The model’s applications extend beyond stress testing, including macroprudential policy stance assessment, capital-at-risk analysis, and macroprudential policy impact evaluation. The SRMS model enhances the understanding of systemic risks within the Lithuanian banking sector and offers a potential benchmark for other national central banks seeking to strengthen their financial stability frameworks.

Keywords: macroprudential stress testing, macroprudential policy, feedback loop, secondround effects.

JEL codes: E37, E58, G21, G28

This paper estimates high-dimensional fixed effects models using detailed administrative data to characterize the public-private wage gap in Lithuania between 2010 and 2020. We document that public sector employees earn on average 10% more than their private sector counterparts. However, when comparing firm-specific wage effects, the gap almost disappears, with public sector employers paying a 0.3% lower premium. Interestingly, women benefit from working in the public sector, as they have a 16% premium due to both being employed by organizations with higher premiums and having higher returns to individual-specific components relative to women in private firms. In contrast, men have higher returns to unobserved permanent heterogeneity, which are particularly high for public sector workers, but they are with employers that have lower premiums relative to men in the private sector, resulting in an observed public sector premium of 4%. Our results highlight the importance of using mobility across firms, not just across sectors, and of isolating firm-specific wage components from other sources of wage variation to properly understand pay differentials across employers with different wage-setting protocols.

Financial fraud is a significant issue not only for the financial sector, but also for society as a whole. It is taking on new forms as a result of the increasing digitalisation, with an upward trend in the number of cases and the losses incurred in many countries. In Lithuania, financial fraud has risen dramatically over the last several years.

The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

Available only in Lithuanian

This paper examines the influence of export activity on a firm’s energy intensity, with a particular focus on the role of the upgrading process. We introduce a firm-level complexity index incorporating two dimensions: the complexity of the goods traded, and the complexity of the destination markets served. By employing a quasi-experimental shift-share research design (Borusyak et al., 2022), we show that growth in external demand incentivizes firms to undertake upgrading activities, resulting in lower energy intensity. Furthermore, financial constraints diminish the energy efficiency gains from upgrading, especially for small firms. In addition, we explore whether upgraded firms can leverage higher markups, and show that this strategy is effective only for large firms. These findings indicate the need for targeted support policies for small firms and highlight the critical importance of maintaining open trade in an increasingly fragmented world.

Keywords: Firm Upgrading, International Trade, Energy Intensity, Complexity, Structural Transformation, Economic Development.

JEL classification: F14, D22, O33, Q56.

Amid ongoing geoeconomic tensions, industrial policy has emerged as a prominent tool for policymakers. What are the dynamic and welfare effects of these policies? How does the short-sightedness of policymakers influence their choice of instruments? What are the distributional consequences of these protectionist measures? We address these questions with a dynamic two-country open-economy macro framework that incorporates firm heterogeneity, trade, and the offshoring of tasks. By calibrating the model to the contexts of the US and China, we explore the effects of four popular industrial policies: import tariffs, offshoring friction, domestic production subsidies, and entry subsidies. Our findings indicate that myopic policymakers are incentivized to subsidize production, while more forward-looking policymakers favor imposing import tariffs. Although all of these policies initially reduce wage inequality, some result in aggregate welfare losses, either in the short run or the long run.

Keywords: Macroeconomic Dynamics, Firm heterogeneity, Trade, Trade-in-tasks, Industrial policies, Welfare, Global value chains.

JEL classification: F23, F41, F51, F62, L51.

This paper presents an analysis of optimal policies within a New Keynesian model that incorporates households’ concerns regarding fair price markups. Fluctuations in inflation shape perceptions of fairness, which constitute a pivotal factor in the design of policies. The optimal fiscal policy is an income subsidy designed to address inefficiencies resulting from price markups; however, it is ineffective in mitigating households’ perceptions of fair pricing. In the event that inflation targeting by the monetary authority is not sufficiently strict, the optimal policy shifts to a tax. The planner is thus able to mitigate both demand-driven inflation and concerns regarding the fairness of pricing, albeit at the cost of welfare losses. Furthermore, an analogous policy to price caps is examined, in which the planner determines an optimal markup path for firms in lieu of providing subsidies to households. This approach is demonstrated to be equivalent to a subsidy within this framework. Consequently, when fairness and inflationary pressures are relatively low to moderate, a price markup cap is an effective means of enhancing welfare. However, as these factors intensify, the planner sets a high markup, resulting in welfare losses.

Keywords: New Keynesian model, fair markups, optimal fiscal policy, price cap.

JEL classification: D11, E10, E31, H21, H31.

The goal of this paper is to determine the heterogeneity in communication among the ECB Governing Council members, employing the GPT language model, and assess its impact on financial markets with high-frequency data since 2014. Our findings uncover trends in sentiments and topics in line with economic developments and similar studies. We highlight a marked divergence between hawkish and dovish members. Using regression analysis, we demonstrate that the communication from the Governing Council members significantly influences various euro area asset classes, particularly Italian sovereign bonds. These effects are consistently significant across different periods. Our study also highlights specific topics that exert a more pronounced influence on market dynamics, notably unconventional monetary policy since 2014 and, more recently, interest rate discussions. Hawkish communication is observed to have a more substantial effect on sovereign bond yields. Furthermore, speeches by Executive Board members and the Governors of Germany, France and Austria are found to have the most significant overall impact on euro area markets.

Keywords: ECB, monetary policy, communication, sentiment analysis, euro area, financial markets.

JEL codes: C80, E43, E44, E58, G14.

We provide evidence regarding how European and U.S. macroeconomic and monetary policy events affect euro area markets. By analyzing over 170 macroeconomic indicators from 2002 to 2024Q1, we assess the impacts across different events, countries, and time periods. We rely on a high-frequency impact identification strategy and estimate the effects of releases on market variability and the directional effects of surprises across different markets. We find that, compared to European data releases, U.S. events tend to have a more pronounced effects on euro area markets. On average, monetary and employment events induce the strongest repricing in euro area financial markets. In most of the specifications, long-term sovereign yields were more sensitive to macroeconomic releases than other instruments, while short-term bonds and stock prices were impacted much less frequently.

Keywords: macroeconomic news, macroeconomic releases, monetary policy, euro area, financial markets.

JEL codes: E43, E44, F40, G12, G14, G15

The Baltic states experienced the most substantial consumer price inflation of any of the EU countries shortly after the COVID-19 pandemic. The year-on-year all-items inflation rate averaged 11% from January 2021 to September 2023, peaking at around 22% in late 2022. This study examines how consumer price rigidity in the region during this period of high inflation differed from the preceding period of low inflation in 2019-2020. We use the detailed price records that underlie the official consumer price indexes to assess the frequency and the size margins of price changes. The average frequency of price changes increased by about four percentage points when inflation was high, as an increase of five percentage points in the frequency of price increases combined with a fall of one percentage point in the frequency of price cuts. The average size of price changes increased by 2.8 percentage points, mainly because the share of price increases changed. We further show that structural shocks in energy prices and aggregate demand contributed significantly to fluctuations in the inflation rate through the frequency of price changes during the period of high inflation. All this points to pricing being state-dependent in the Baltic states.

Keywords: consumer price rigidity, price-setting, high inflation, frequency of price changes.

JEL classification: D40, E31.

As house price growth accelerated during the pandemic, housing affordability in Lithuania started to deteriorate for the first time in a decade. This trend did not last long and, as price growth slowed down and incomes continued to rise rapidly, signs of improving affordability have already become visible from 2023. Although the deterioration in housing affordability in Lithuania was a temporary phenomenon caused by strong external shocks, it is important that housing policy in Lithuania provides the conditions for a structurally sustainable level of affordability. In this study, the Bank of Lithuania has analysed various indicators of housing affordability and the demand and supply factors that may it. The results of the study have led to four main orientations for sustainable housing policy: to achieve sustainable housing demand developments, a larger and more flexible supply of quality housing, meeting the housing needs of socially vulnerable people, and creating a long-term and common housing policy strategy.

The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

Available only in Lithuanian

We document how worker flows between employment, unemployment, and out of the labor force, vary by age and gender for a large panel of European countries. We develop and calibrate an extended Diamond-Mortensen-Pissarides model that captures all the salient features of these data. The model assigns a major role to the production technology in driving differences in aggregate employment, while, in contrast to Standard analyses, labor-market policies play only a secondary role. Search intensity and a laborforce participation decision are key for propagating the effects of technology across age and gender groups, and for explaining the variation in aggregate employment.

Keywords: Employment, Unemployment, Labor Force Participation, Life cycle, Worker Flows, Labor Market Institutions

JEL classification: E02, E24, J21, J64, J82