Publications

The Circular Economy (CE) challenges the traditional linear economy model to arrive at a sustainable  economy that minimizes resource use, its negative environmental impact, and dependency on resource imports. We develop a multi-sector dynamic stochastic general equilibrium small open economy model with endogenous adoption of exogenous foreign technology innovations, endogenous environmental quality, and CE elements, comprising recyclable waste as well as recycling and refurbishing sectors. We analyze the model-implied impulse response functions with respect to several economic shocks and conduct a rich scenario-based analysis, for which the scenarios are derived from the 9R strategies. We find important trade-offs to be considered by the economy with respect to circularity, trade, environment, and growth – the four dimensions of the quadrilemma of a small open circular economy. We find that none of the six shocks considered and in none of the eight scenarios analyzed the quadrilemma can be resolved. However, a positive shock to the price of energy or a lower energy share in one of the two intermediate goods sectors provide benefits to three out of four dimensions of the quadrilemma.

Keywords: Circular economy, Small open economy, Recycling, Refurbishing, Endogenous economic growth, Technology adoption, General equilibrium, Energy.

JEL codes: E2, F4, O3, O4, Q4, Q5.

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

We develop a fiscal dynamic stochastic general equilibrium (DSGE) model for policy simulation and scenario analysis purposes tailored to Latvia, a small open economy in a monetary union. The fiscal sector elements comprise government investment, government consumption, government transfers that are asymmetrically directed to both optimizing and hand-to-mouth households, cyclical unemployment benefits, foreign ownership of government debt, import content in public consumption and investment, and fiscal rules for each fiscal instrument. The model features a search-and-matching labour market friction with pro-cyclical labour costs, a financial accelerator mechanism, and import content in final goods. We estimate the model using Latvian data, study the new channels in the model, and provide a comprehensive analysis on the macroeconomic effects of the fiscal elements. A particular finding is that having foreign ownership of government debt generally breaks the Ricardian equivalence paradigm.

JEL codes: E0, E2, E3, F4, H2, H3, H6

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

This paper analyzes the transition to a low-carbon economy and its effects on macroeconomic quantities and asset prices. Empirically, we document that the relative valuation of fossil fuel firms has significantly declined with the rise of climate change risk awareness. We develop a macro asset pricing model for the climate transition that matches this empirical fact and allows us to characterize the dynamics of macroeconomic aggregates and asset prices during and after the transition. In particular, we analyze (i) firm valuation dynamics, (ii) climate policy risk premia, (iii) capital reallocation between sectors, and (iv) the behavior of oil prices.

JEL Codes: E2, E3, G12, Q43.

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

This study develops a symmetric two-country New-Keynesian general equilibrium model with endogenous growth, Calvo-style price and wage rigidities, and international trade of final consumption goods and intermediate goods. The equilibrium implications of two financial market structures are compared: financial autarky and complete markets. In the case of financial autarky, no international bond is traded. In the case of complete markets, the households have access to a full set of international nominal state-contingent bonds. We find that assuming complete markets instead of financial autarky leads to higher co-movement of most macroeconomic growth rates across countries, higher co-movement of inflation rates across countries, lower uncovered interest rate parity regression coefficients, and a lower correlation between exchange rate growth and consumption growth differentials. These results are mostly in line with US and UK data from 1950-2015, which are split into two samples, 1950-1970 and 1971-2015, in order to be compared to the model with financial autarky and the model with complete markets, respectively.

JEL Codes: E30, E44, F44, G12, O30.

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

We shed new light on the macroeconomic effects of rising temperatures. In the data, a shock to global temperature dampens research and development (R&D) expenditure growth. This novel empirical evidence is rationalised within a stochastic endogenous growth model. In the model, Temperature shocks undermine economic growth via a drop in R&D. Moreover, temperature risk generates welfare costs of 13.50% of lifetime utility. The government can offset these welfare costs by subsidizing investment with 1.02% or R&D expenditure with 0.52% of total public spending, respectively. Alternatively, it can levy a lump-sum tax on households which finances 0.64% of total public spending.

JEL Codes: E30, G12, Q00.

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

Empirical evidence suggests that investments in research and development (R&D) by older and larger firms are more spread out internationally than R&D investments by younger and smaller firms. In this paper, I explore the quantitative implications of this type of heterogeneity by assuming that incumbents, i.e. current monopolists engaging in incremental innovation, have a higher degree of internationalization in their R&D technologies than entrants, i.e. new firms engaging in radical innovation, in a two-country endogenous growth general equilibrium model. In particular, this assumption allows the model to break the perfect correlation between incumbents’ and entrants’ innovation probabilities and to match the empirical counterpart exactly.

JEL Codes: E22, F31, G12, O30, O41.

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

The international diffusion of technology plays a key role in stimulating global growth and explaining co-movements of international equity returns. Existing empirical evidence suggests that countries are heterogeneous in their attitude toward innovation: Some countries rely more on technology adoption while other countries rely more on internal technology production. European countries that rely more on adoption are also typically characterized by lower fiscal policy flexibility and higher labor market rigidity. We develop a two-country model, in which both countries rely on R&D and adoption, to study the shortand long-run effects of aggregate technology and adoption probability shocks on economic growth in the presence of the aforementioned asymmetries. Our framework suggests that an increase in the ability to adopt technology from abroad stimulates future economic growth in the country that benefits from higher adoption rates but the beneficial effects also spread to the foreign country. Moreover, it helps to explain the differences in macro quantities and equity returns observed in the international data.

JEL Codes: E3, F3, F4, G12.

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

We study the general equilibrium implications of different fiscal policies on macroeconomic quantities, asset prices, and welfare by utilizing two endogenous growth models. The expanding variety model features only homogeneous innovations by entrants. The Schumpeterian growth model features heterogeneous innovations: “incremental” innovations by incumbents and “radical” innovations by entrants. The government levies taxes on labor income and corporate profits and supplies subsidies to consumption, capital investment, and investments in research and development by entrants and, if applicable, incumbents. With these models at hand, we provide new insights on the interplay of innovation dynamics and fiscal policy.

JEL Codes: E22, G12, H20, I30, O30.

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

This paper proposes and tests a new source of time variation in real investment opportunities, namely long-run shocks to the productivity of the investment sector, to explain the joint behavior of macroeconomic quantities and asset prices. A two-sector general equilibrium model with long-run investment shocks and wage rigidities produces both positive co-movement among key macroeconomic variables and a sizable return volatility differential between the investment and consumption sector. Moreover, positive long-run investment shocks are associated with low marginal utility and thus command a positive risk premium. We test our model using data on sectoral TFP and find evidence in support of our theoretical predictions.

JEL Codes: E32, G12.

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

Also published in the Journal of Economic Dynamics and Control, Volume 78, Pages 118–148

This paper studies a two-country production economy with complete and frictionless financial markets and international trade in which competition in R&D leads to endogenous new firm creation and economic growth. Current monopolists (“incumbents”) and potential new firms (“entrants”) compete in developing patents domestically. These innovative firms use both consumption goods in their R&D technologies to capture international technological spillovers. In the model specifi- cations with technology spillover one obtains that (i) the cross-country correlation of consumption growth is lower than the one of output growth; (ii) net exports are negatively correlated with output; (iii) the model matches the high co-movement of stock returns across countries. Furthermore, heterogeneity in the R&D technology bundle home bias parameters for incumbents and entrants enables the model to replicate the empirically rather moderate correlation between the R&D innovation probabilities of incumbents and entrants within a country. Moreover, the model produces a positive value premium. Finally, the exchange rate volatility is decreasing in the amount of technology spillovers.

JEL Codes: E22, F31, G12, O30, O41.

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

The term ‘financialization’ describes the phenomenon that commodity contracts are traded for purely financial reasons and not for motives rooted in the real economy. Recently, financialization has been made responsible for causing adverse welfare effects especially for low-income and low-wealth agents, who have to spend a large share of their income for commodity consumption and cannot participate in financial markets. In this paper we study the effect of fi- nancial speculation on commodity prices in a heterogeneous agent production economy with an agricultural and an industrial producer, a financial speculator, and a commodity consumer. While access to financial markets is always beneficial for the participating agents, since it allows them to reduce their consumption volatility, it has a decisive effect with respect to overall welfare effects who can trade with whom (but not so much what types of instruments can be traded).

JEL Codes: E23, G12, G13, Q11, I30.

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

We extend the endogenous growth model of Kung and Schmid (2015) by adding endogenous labor dynamics and wage rigidities. This leads to an increase of about 250 basis points in risk premia. Additionally, it brings labor market quantities much closer to their empirical counterparts. In particular, wage rigidities generate an increase of around 60 basis points in labor growth volatility.

JEL Codes: E22, G12, O30, O41.

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