Publications

The empirical and theoretical evidence on the inflation impact of population aging is mixed, and there is no evidence regarding the volatility of inflation. Based on advanced economies’ data and a DSGE-OLG model - a multi-period general equilibrium framework with overlapping generations, - we find that aging leads to downward pressure on inflation and higher inflation volatility. Our paper is also the first to discuss, using this framework, how aging affects the short-term cyclical behavior of the economy and the transmission channels of monetary policy. Further, we are also the first to examine the interplay between aging and optimal central bank policies. As aging redistributes wealth among generations, generations behave differently, and the labor force becomes more scarce with aging, our model suggests that aging makes monetary policy less effective, and aggregate demand less elastic to changes in the interest rate. Moreover, in more gray societies central banks should react more strongly to nominal variables, and in a very old society the nominal GDP targeting rule might become the most effective monetary policy rule to compensate for higher inflation volatility. 

JEL Codes: E31, E52, J11.

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

Do labor market reforms initiated in periods of loose monetary policy yield different outcomes from those that were introduced in periods when monetary tightening prevailed? Since economic theory usually pays attention to the steady state change and ignores business cycle interactions of structural reforms, we connect local projection methodology with the Mallow’s C_p averaging criterion to arrive at an inference that does not require knowledge of the exact functional form, is robust to mis-specification, admits non-linearities, and cross-sectional dependence and addresses uncertainty regarding interactions between labor reforms and macroeconomy. We also develop a test to check the importance of monetary policy for any horizon and the entire impulse response function, taking the multiple testing problem into account. We document that replacement rates deliver substantially different outcomes on real GDP, inflation and real effective exchange rate, whereas labor activation schemes bear different effects on unemployment in low- and high-interest rate environments. There is also evidence of monetary policy trend playing an important role as well as increasing synchronized monetary and labor market policies across European countries.

JEL Codes: C33, C54, E52, E62, J08, J38.

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

This paper examines how monetary policy affects income inequality in 10 euro area countries over the period 1999–2014. We distinguish macroeconomic and financial channels through which monetary policy may have distributional effects. The macroeconomic channel is captured by wages and employment, while the financial channel by asset prices and returns. We find that expansionary monetary policy in the euro area reduces income inequality, especially in the periphery countries. The macroeconomic channel leads to these equalizing effects: monetary easing reduces income inequality by raising wages and employment. However, there is some indication that the financial channel may weaken the equalizing effect of expansionary monetary policy. 

JEL Codes: D63, E50, E52.

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

Online appendix (204.3 KB download icon)

The Great Recession has strongly influenced employment patterns across skill and gender groups. This paper analyzes how the resulting changes in non-employment have affected selection into jobs and hence gender wage gaps. Using data for the European Union, we show that male selection into the labour market, traditionally disregarded, has become positive. This is particularly so in Southern Europe, where dramatic drops in male unskilled employment have taken place during the crisis. As regards female selection, traditionally positive, we document two distinct effects. An added-worker effect has increased female labour force participation and hence reduced selection in some countries. In others, selection has become even more positive as a result of adverse labour demand shifts in industries which are intensive in temporary work, a type of contract in which women are over-represented. Overall, our results indicate that selection has become more important among men and less so among women, thus changing traditional gender patterns and calling for a systematic consideration of male non-employment when studying gender wage gaps.

JEL Codes: J31.

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.

This paper builds a theoretical model that introduces frictional unemployment in a two-sector multi-worker heterogeneous firms model with a dynamic matching process. In doing so, we have a rich environment that combines product, labour, and international markets. A change in labour market policies (unemployment benefits and employment contingent subsidies) transforms the share of exporters and affects average productivity. Empirical evidence confirms a robust positive effect of employment subsidies on openness, little, if any, impact of subsidies and a positive effect of replacement rate on unemployment. Closure of equilibrium plays an important role to explain data facts about employment subsidies: using sectoral arbitrage condition, subsidies cease affecting unemployment and make openness grow, consistently with the empirical evidence. Unemployment benefits, on the other hand, make unemployment and openness rise, independently of sectoral reallocations. In addition, we find that unemployment benefits bear different policy implications with regards to international coordination than employment subsidies.

JEL Codes: E24, F12, F16.

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

Southern Europe is currently experiencing a double-whammy: high levels of government debt coupled with a rapidly aging population. Thus, the consolidation of (pension) budgets seems inevitable. In this paper we examine the short- and long-run macroeconomic effects of public old-age pension reforms and other fiscal policies under conditions of population aging. To do so, we calibrate OGRE, a New Keynesian model with overlapping generations, unemployment and an underground sector to match annual data on Portugal and Spain. Our main finding is that a retirement-age increase is the least harmful policy with respect to long-run output. However, we raise some doubts about the feasibility of implementing this policy.

JEL Codes: E24, E26, H55, J11, J46.

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

In this paper we present the structure of OGRE, a dynamic general equilib-rium model with overlapping generations, unemployment and a shadow economy. Based on a parametrized version of the model, we examine the impacts of aging and calculate multipliers of public pension and other fiscal policies. Also, we contrast macroeconomic reactions with pay-as-you-go and fully funded pension plans. Lastly, we highlight the role of unemployment and that of the underground sector in the framework.

JEL Codes: E24, E26, H55, J11, J46.

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

This paper studies the link between demographic factors and labour shares as well as tries to answer the question whether population ageing is responsible for the global decline in labour shares. We found that the link depends on the elasticity of substitution between labour and capital as production factors. Given the empirical estimates of this parameter, we conclude that population ageing is not responsible for the global decline in labour shares. On the contrary, it reduces the speed of this decline.

JEL Codes: E25, C51, J14.

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

This paper provides an explanation as to why population ageing is associated with deflationary processes. For this reason we create an overlapping-generations model (OLG) with money created by credits (inside money) and intergenerational trade. In other words, we combine a neoclassical OLG model with post-Keynesian monetary theory. The model links demographic factors such as fertility rates and longevity to prices. We show that lower fertility rates lead to smaller demand for credits, and lower money creation, which in turn causes a decline in prices. Changes in longevity affect prices through real savings and the capital market. Furthermore, a few links between interest rates and inflation are addressed; they arise in the general equilibrium and are not thoroughly discussed in literature. Long-run results are derived analytically; short-run dynamics are simulated numerically.

JEL Codes: E12, E31, E41, J10.

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

Appendix (6.9 MB download icon)

Recent turbulent times have once again demonstrated how important flexible product and labour markets are to dampen the effects of adverse economic shocks. A number of labour market reforms have been implemented to enhance economic resilience and flexibility. However, accounting for the efficacy of policy interventions requires going beyond national boundaries and evaluating international interactions and global interdependencies, which may strengthen or weaken economic responses. Concentrating on open European economies, this paper deals with labour market institutions and structural reforms in a general equilibrium framework, which allows to analyse the intricate connections between labour policy choices and international trade (openness), paying special attention to labour market policy shocks. Amid discussions about a fiscal union in Europe, we empirically demonstrate that labour market policies can have positive and negative spillovers to trading partners, thereby calling for coordinated policies within a trading bloc. We answer three types of questions: what would have happened had all economies implemented structural labour market reforms simultaneously? How heterogeneous are responses in a single economy to shocks conducted in every other country? Relatedly, how heterogeneous are responses by all economies to a reform in one given economy?

JEL Codes: C32, C33, E24, F12, F16.

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

This paper presents a simple condition for optimal asymmetric labour (capital) taxation/subsidization in a two-sector model with logarithmic utilities and Cobb-Douglas production functions, linked to demographic factors: fertility rate and longevity. The paper shows that depending on parameter values, it may be optimal to tax or subsidize labour in the sectors. If it is optimal to tax the investment-goods sector, a Pareto-improving tax reform is possible. Larger output elasticities of capital in the sectors reduce the possibilities of a Pareto-improving reform, while population ageing in terms of higher longevity enhances the possibilities of welfare improvement for all generations. Fertility rates do not affect optimal taxation.

JEL Codes: E62, H21, J10.

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

The paper provides estimates for the New Keynesian Phillips curve (NKPC) in Lithuania. The paper considers the baseline and hybrid NKPC, the latter accounting for inflation inertia, under the closed and open economy frameworks. The estimates highlight the importance of expected and lagged inflation in the inflation formation process. The role of real marginal cost is found to be limited in shaping the dynamics of inflation. The study yields estimates for the underlying characteristics of pricing behaviour in Lithuania. The estimates show that the price duration stands at around 2.2–2.8 quarters, while the fraction of firms that adjust prices in a backward looking way amounts to around one third.

JEL Codes: D40, E30.

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

This paper investigates the wage and price setting behaviour of Lithuanian firms on the basis of an ad hoc survey “On Price and Wage Setting” undertaken by the Bank of Lithuania. The paper provides survey evidence on the frequency of wage and price changes. The frequency of wage changes turns out to be higher in firms that apply collective pay agreements, while the frequency of price changes appears to be positively affected by the market competition. Labour cost share is not found to be significant in making the impact on the frequency of price changes. This paper also investigates the role of certain technological, institutional and other factors in shaping firms’ responses to a negative demand shock, an intermediate input cost shock and a wage shock. A higher labour cost share is found to increase the likelihood of a price increase following a wage shock. Flexible wage components mitigate firms’ responses to a slowdown in demand and an intermediate input cost increase. The behaviour of firms following the investigated shocks is also affected by the level of competition. The role of collective pay agreements appears to be rather limited in shaping responses of firms to the shocks.

JEL Codes: D40, J30.

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

In this paper, the economic impact of the 2006–2008 personal income tax (PIT) reform in Lithuania is analyzed applying model-based simulations. We find that the undertaken PIT reform is unsustainable as it leads to permanent government budget deficits and ever increasing public debt. This result holds even allowing for endogenous reduction in tax evasion. After introducing permanent compensatory fiscal measures ensuring long-term sustainability of the PIT reduction, we demonstrate that the lower PIT produces higher output and lower prices in the long run. Higher domestic spending is supported by higher employment and after-tax wages. Moreover, following a reduction in the marginal production costs, producer prices fall enhancing economy’s international competitiveness and boosting domestic exports. Pre-announcement of the tax reform implies early macroeconomic reaction, and thus in most cases smoother adjustment of the economy to the tax change.

JEL Codes: E62, H24, H25, H26.

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