Since the launch of the euro, the Euro Area has combined weak growth with persistent trade surpluses, a rising trade share, and the absence of a real exchange rate trend. In academic and policy debates, the Euro Area's trade surplus is often viewed as reflecting weak domestic aggregate demand. This paper argues that a purely demand-based view of the trade balance is incomplete. Using an estimated two-region framework, we find that slower productivity growth in the Euro Area has been a major driver of the trade surplus since 1999, while demand shocks play an important role in the rising trade balance following the global financial crisis. We further show that real exchange rate dynamics cannot be understood from productivity growth differentials and aggregate demand shocks alone, but also reflect longer-run shifts in trade patterns.

In this paper, we model a fossil fuel embargo as a temporary quantity constraint on fossil fuel imports and we compare the impact with the effect of a fossil fuel price shock. We show that while both shocks have similar responses of output and inflation, they differ with respect to the reaction of other macroeconomic components, such as consumption, exports and the trade balance. In particular, an embargo has more adverse effects on the functional income distribution. Our findings are relevant for policymakers when determining the most effective stabilization policy. We compare different monetary and fiscal stabilization policies, such as different interest rate policies, energy tax reduction, transfer to liquidity-constrained households, and a value-added tax cut. We find that fiscal policy can complement monetary policy, by targeting distributional objectives. There is no conflict with monetary policy in the case of energy taxes and VAT, while in the case of transfers output and consumption stabilization of low-income households is accompanied by slightly higher inflation. We find that fiscal policies are less effective in stabilizing GDP in the case of an embargo shock. In particular, a reduction of the energy tax is completely ineffective when there is an embargo. In contrast, in the event of a fossil fuel price shock, an energy tax reduction is effective because it counteracts the price increase and allows companies to respond according to their energy demands.

This paper provides a new method to estimate price-cost margins in the presence of fixed costs of production. By exploiting properties of the primal and dual sales-based and cost-based Solow residuals, we are able to simultaneously estimate price-cost margins and the share of fixed costs in total costs for each input. Ignoring fixed costs in production underestimates price-cost margins and overestimates excess profit shares. Using a thirty-year panel of Belgian firms, we estimate price-cost margins, as a fraction of sales, of 25.4% on average, which can be decomposed between fixed costs of 22.9% and excess profits of 2.5%. Belgian price-cost margins have declined (-5.9%) in the past three decades due to a combination of falling fixed costs (-4.0%) and decreasing excess profits (-1.9%), suggesting that output markets have become even more competitive over time. While large firms have higher profit shares than small firms, they have lower fixed cost shares as well as lower price-cost margins.

We estimate an open economy DSGE model to study the fiscal policy implications of downward nominal wage rigidity (DNWR) in a monetary union. DNWR has significantly exacerbated the recession in the southern euro area countries and is important for the design of fiscal policy. We show that a cut in social security contributions paid by employers (equivalent to wage subsidies) is particularly effective in a deep recession with limited wage adjustment. Such cuts strengthen domestic demand and international competitiveness. Compared to government expenditure increases, the reduction in social security contributions provides more persistent growth effects and enhances the fiscal position. Non-linear estimation methods establish a strong state-dependence of policy.

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The system of business income taxation consists of two instruments, namely a statutory tax rate and a depreciation allowance on investment. We will show in this paper that by acting on both instruments simultaneously it is possible to achieve both a growth and a fiscal net revenue target even in cases when a trade-off prevails when each instrument is used individually.As will be shown in the paper, depreciation allowances have a more favorable trade-off between growth and net revenue in the long run compared to statutory business income tax rates. Thus, by rising depreciation allowances and the statutory tax rate at the same time, it is possible to both increase growth and fiscal space.In a model simulation calibrated to the German economy and tax system, an increase of the tax depreciation rate for all investments from 10% to 25% leads to a more than 2 percent GDP increase and more than 6 percent higher private investments in total. Whereas GDP and investment rise steadily over time, the government budget becomes negative in the short run. In the long run, the sign of the fiscal budget effect is determined by the indexation of government consumption to GDP. However, according to our findings, slight adjustments in the statutory business income tax rate could balance out these deficits and generate additional fiscal space.

We develop a New Keynesian (NK) model with endogenous price setting frequency. Whether a firm updates its price is a discrete choice: when expected benefits outweigh expected costs, prices are reset optimally. The model gives rise to a non-linear Phillips curve as prices are more flexible during demand-driven expansions and less so during demand-driven recessions. Monetary policy can have substantial real effects despite the model having a state-dependent pricing component. Our quantitative analysis shows that contrary to the standard NK model, the assumed price setting behavior: (i) is consistent with micro data on price setting frequency; (ii) generates a direct effect of the time-varying price setting frequency on inflation; (iii) creates time-variation in the Phillips curve slope that explains shifts in the Phillips curve associated with different historical episodes; (iv) explains inflation dynamics without relying on implausible high cost-push shocks and nominal rigidities inconsistent with micro data; (v) reconciles the NK model with observed inflation moments.

In this paper, we focus on the impact of a occasionally binding quantity constraint on fossil fuel imports and compare the effects with those of an exogenous fossil fuel markup price shock. We show that while both shocks have similar responses to GDP and CPI inflation, they differ with respect to other macroeconomic components, such as consumption, exports, the trade balance and the functional income distribution.Our findings are relevant for policymakers when determining the most effective fiscal stabilization policy. We compare different temporary fiscal stabilization policies, such as energy tax reduction, transfer to liquidity-constrained households, and a valued-added tax cut. We find that fiscal policies are less effective in the case of an embargo shock. In particular a reduction of the energy tax is completely ineffective when there is an embargo. In contrast, in the event of a price markup shock, an energy tax reduction is effective because it counteracts the price increase and allows companies to respond according to their energy demands.In the case of an embargo, we show that transfer policies which redirect income to households receiving mostly labor income have good stabilization properties. However, this policy measure leads to a higher increase in all inflation rates which could widen the monetary policy trade-off between stabilizing output and inflation.

Der russisch-ukrainische Krieg hat eine lebhafte Debatte über die angemessenen sanktionspolitischen Möglichkeiten Deutschlands bzw. der Europäischen Union ausgelöst: Idealerweise sollten Sanktionen Russland erhebliche wirtschaftliche Kosten auferlegen und dazu beitragen, die Fähigkeit und Bereitschaft der russischen Regierung zur Fortsetzung ihrer militärischen Aggression gegen die Ukraine zu verringern. Es werden zwei Optionen diskutiert, nämlich ein Embargo auf russische Exporte fossiler Brennstoffe und ein Importzoll. Wenn die europäischen Entscheidungsträger die Option eines Gasimportzolls auf russische Exporte in Betracht ziehen wollen, müssen bei der Abwägung der Vor- und Nachteile einer solchen politischen Option die folgenden Punkte berücksichtigt werden: Erstens die Auswirkungen auf Russland – insbesondere die Auswirkungen auf die russischen Haushaltseinnahmen – und auf Gazprom als den weitgehend in Staatsbesitz befindlichen dominierenden Gasexporteur. Zweitens muss sich die Analyse auf die Auswirkungen auf die Verbraucher von importiertem Erdgas in der Europäischen Union konzentrieren. Die Befürworter eines Importzolls berufen sich auf die Theorie der optimalen Zölle und argumentieren, dass eine solche Politik die Last in erster Linie auf die Exporteure fossiler Brennstoffe verlagern würde, da die Zolleinnahmen dem EU-Haushalt zufließen. Es gibt klare Argumente dafür, dass eine Duopol-Marktstrukturanalyse nützlich ist, um die wichtigsten Auswirkungen eines EU-Importzolls abzuleiten, da ein solcher Ansatz die Berücksichtigung von Mitnahmeeffekten für Wettbewerber, die Berücksichtigung von Kostenunterschieden zwischen Anbietern und die Möglichkeit von Veränderungen der Marktführerschaft erlaubt. Wir betrachten die Auswirkungen von aufkommensmaximierenden Zöllen sowohl für den Fall, dass Gazprom seine Marktführerschaft behält, als auch für den Fall, dass es sie verliert. Der zollmaximierende Zoll würde den Marktanteil von Gazprom erheblich verringern, und Gazprom würde die Gaspreise nur teilweise erhöhen, nämlich um 50 Prozent des Zolls, wenn die Marktführerschaft erhalten bleibt, und um etwa 25 Prozent, wenn die Marktführerschaft verloren geht. Allerdings würden auch die Wettbewerber ihre Preisaufschläge erhöhen, und zwar noch stärker, wenn sie Marktführer werden. Die Preisaufschläge und der Rückgang des Marktanteils von Gazprom machen es im Vergleich zum (analytischen) Monopolfall schwieriger, ausreichende Zolleinnahmen von Gazprom zu erzielen, um die Verbraucher in der EU zu entschädigen – das sollte seitens der EU-Länder bei der Auswahl alternativer Sanktionsstrategien bedacht werden.

This paper describes a micro-founded, fully forward-looking dynamic general equilibrium model with energy sectors to analyze the macroeconomic impact of climate mitigation policy in the European Union. The paper presents simulation results for the transitional costs of moving toward a net-zero emissions economy in a budgetary-neutral way through regulation and carbon taxes. Our model allows for substitutability between fossil fuels and clean energy inputs and considers different recycling options for the revenues collected by carbon taxes. We find that the costs of moving toward a net-zero emissions economy can be significantly reduced when carbon taxes are recycled to reduce other distortive taxes or subsidize clean energy. Our scenarios also show that carbon pricing can be less regressive than regulation-based policies.

This paper revives the question of whether a temporary VAT change is an adequate instrument for crisis stabilization. In empirical assessments, we find that durable goods consumption fluctuates strongly over the business cycle and that VAT rate changes affect durable goods in particular. Therefore, we build a dynamic stochastic general equilibrium (DSGE) model that is capable of addressing this major channel through which temporary VAT changes affect the economy. Furthermore, we allow for an imperfect pass-through of VAT measures to consumer prices via VAT-specific price adjustment costs. We compare the general VAT policy in the crisis with alternative stabilization policies, such as interest rate cuts, spending policies and a VAT cut only for durable goods. First, we find that considering durable goods in the model generates sizeable stabilization effects of VAT changes on consumption over a broad set of parameter ranges. Second, we find that the VAT policy can mimic monetary policy with minor exceptions. Third, the VAT rate cut has the highest short-term multiplier compared with government spending policies, but not in the medium-term. Fourth, a VAT rate reduction only on durable goods will generate strong GDP effects and even be self-financing in the first year. In contrast, a VAT reduction only on non-durables has small effects on GDP and is not self-financing. In view of our results, we conclude that a temporary VAT cut, when applied to durable goods, is an effective stabilization instrument.

The merit-order approach in the electricity market, which is in widespread use across the EU27 and the UK, has proven to be somewhat economically problematic in the context of the Russo-Ukrainian War. The massively increased gas prices since summer 2022—in the context of Russian supply cuts to the EU—has led to an abnormally high electricity price. Using the merit order approach, the price of electricity increases enormously if, as is often the case, gas is the last type of energy still realized in power generation; this leads to artificial increases in returns for all other types of energy providers whose output is used in power generation. Gas price increases by Russia or Russian supply cuts to the EU can increase the price of electricity and also the rate of inflation, as well as depress real income. The electricity price shock can be countered by switching—temporarily—to a modified regulation of the electricity market for a few years with a gas price subsidy in the electricity market. In a macroeconomic analysis, we identify both the output losses and adverse distributional effects of a gas price hike and find that a gas price subsidy is superior in stabilizing output and employment compared to a transfer; it also at least partially addresses certain distributional issues by reducing windfall profits in the electricity market. The study advocates a combination of gas price subsidies only in the electricity market and targeted transfers to households to meet both efficiency and distributional targets. The macro-analysis findings presented herein should be considered carefully, as they could minimize the welfare losses in the EU and the UK. As regards the expansion of renewable energy-based electricity, it is shown herein that the cost-differential between gas-fired power stations and renewable electricity is critical—large cost differentials imply barriers for the expansion of electricity generation from renewables unless there is a price regulation of electricity. There is the potential for an inefficient adjustment path due to nonlinearities. With a proposed narrow gas price cap for the electricity market only, the associated initial deficit related to necessary subsidies is, of course, much smaller than in the case of a general gas price cap.

Zusammenfassung Die Politik in Deutschland und vielen anderen EU-Ländern hat seit Spätsommer 2022 zunehmend die Option einer Gaspreisbremse und von Transferzahlungen an private Haushalte bei Gas-, Wärme- und Strombezug diskutiert. Wie eine Gaspreisbremse ausgestaltet sein soll — für jede Gaskundschaft im Haushalts- und Industriebereich oder nur für bestimmte gasverbrauchende Sektoren -, ist bislang analytisch kaum ausgeleuchtet. In Deutschland hat die Kommission für Gas und Wärme Vorschläge gegen die Energiepreisschocks geliefert, wobei von der Politik auch noch eine EU-Verzahnung angedacht ist: Von der Bundesregierung wurde auf dem Brüsseler EU-Ratsgipfel im Oktober bislang nur grünes Licht für ein Mehr an gemeinschaftlichem Gaseinkauf gegeben. Auf Basis eines makroökonomischen Modells wird aufgezeigt, dass ein spezieller Gaspreisdeckel nur beim Strommarkt — ergänzt um bestimmte Transfermaßnahmen — für die Volkswirtschaft ökonomisch optimal ist.

Recent (de-)globalization tendencies and rising protectionist measures has created new interest in studying the effects of unilateral and world-wide tariffs. This paper contributes to this issue by taking into account that international transactions in goods and services increasingly take the form of foreign direct investment. We look at the effects of import tariffs in the context of a two-region DSGE model with both an exporting and an FDI sector. We find that the tariff jumping effect on FDI is largely outweighed by a cost effect if the tariff is imposed on all imports. This holds in the case of both tariffs imposed unilaterally and worldwide import tariffs. Our analysis confirms the aggregate positive welfare effects of a unilateral tariff, but also shows inefficiencies resulting from consumption and production distortions. This leads to lower GDP and real wages through the investment channel. However, governments can generate a tariff jumping effect by exempting imports of multinationals from tariffs. This reduces negative growth effects but also lowers welfare gains since there are less tariff revenues to support consumption. In the case of a world-wide tariff, exempting imports of multinationals reduces negative welfare effects.

This paper analyzes optimal fiscal policy when the rate at which governments can borrow changes persistently. To analyze trade-offs, we allow for fiscal distortions and productive government spending and characterize the optimal mix between spending and revenue measures in a low rate environment. We find that low interest rates on government bonds can be welfare-enhancing if used by the government for fiscal measures that reduce the level of distortion, notably the labor tax, permanently. In the case of a general "flight-to-quality”, where households ask for a premium for holding physical (private) capital, the optimal policy is to increase the public-to-private capital ratio for as long as the shock persists. The associated financing needs should be met by a small increase in government debt and a temporary capital tax.

This paper evaluates the temporary VAT reduction introduced by the German government over the third and fourth quarter of 2020 as most controversial part of the COVID-19 stimulus package. Critics argue that VAT reductions are ineffective because of limited pass-through of temporary measures to consumer prices and in presence of lockdown measures. Advocates emphasize positive effects on durables and stress that a VAT reduction can at least partly substitute for a limited monetary policy response under the ZLB. We build a DSGE model which is capable to address these channels. Our model distinguishes between sectors directly and indirectly affected by the lockdown. This allows us to trace economic spillovers of lockdown measures to the rest of the economy and the differentiated impact of VAT measures on both sectors. We disaggregate consumption into durables and non-durables for both financially constrained and unconstrained households and we allow for imperfect pass-through of VAT measures into consumer prices. In general, if we include the durable investment channel we find robust sizeable effects of VAT changes on consumption even under a limited VAT pass-through. For the specific situation in Germany, we analyze the impact of the VAT reduction in conjunction with the lockdowns in 2020 Q2 to Q4. We use non-linear solution techniques to solve the model in the presence of a ZLB, forced savings and a lockdown constraint. We find a VAT short-term multiplier of one, which reduces over the medium term. Thus, the temporary VAT reduction is an effective instrument in the short-term but not efficient with regard to medium-term budget sustainability. Furthermore, we can show that the VAT reduction is able to mimic the macroeconomic effects of a central bank reaction according to a Taylor rule in case of a lockdown shock. However, compared to the monetary policy reaction the VAT reduction has only small direct effects on private investments.

This chapter provides a description of the QUEST III model, with a special emphasis on its innovation mechanisms, and offers an example of its application to the analysis of the impact of innovation policies in the EU. In particular, the results of the simulations of an ex-ante impact assessment of Horizon Europe Framework Programme 2021–2027 are presented and discussed.

Frequently, factors other than structural developments in technology and production efficiency drive changes in labor productivity in advanced economies (AEs) and emerging market and developing economies (EMDEs). In this paper, we contrast the responses of AEs and EMDEs to innovations in technology and investigate whether the cross-country co-movement in productivity is due to technological or non-technological factors. We find that technological innovations are associated with higher and more rapidly increasing rates of investment in EMDEs relative to AEs, suggesting that positive technological developments are often capital-embodied in the former economies. Employment falls in both AEs and EMDEs following positive technology developments, with the effect smaller but more persistent in EMDEs. Low cross-country correlations of technological developments suggest that global synchronization of labor productivity growth is primarily due to non-technological influences. Overall, non-technological factors accounted for most of the fall in labor productivity growth during 2007-09 but less than one-half of the longer-term productivity decline after the global financial crisis in the median AE and EMDE.

A deeper macroeconomic analysis of foreign direct investment (FDI), innovation and other key variables is needed to better understand technology shock effects, transmission dynamics and policy perspectives in open economies. FDI outward stock relative to the source country total capital stock was above 10 percent in nine OECD countries in 2017, including the UK and the US. This paper adds FDI to a standard model with a tradable and a non-tradable sector. Here, we define non-tradable in a broad sense. The non-tradable sector covers those firms which are located in the tradable sector but undertake FDI in order to overcome the costs associated with exports but it also includes firms in the service industry who offer services which are intrinsically non-tradable, but which can be offered internationally via subsidiaries. This relates to traditional services (e.g., in retail) but also to novel digital services. We study how opening up the non-tradable sector to international transactions (via FDI) affects the international transmission of technology shocks and of persistent demand shocks. We consider a wide range of technology shocks differentiated by product and process innovations and by sectoral origin. Product innovations in formerly non-tradable sectors widen the scope in which innovations in one country can be transmitted abroad. One major difference between FDI and trade is the location of production, which induces different international income flows and requires upfront investment in the case of FDI. We show that this has implications for both the current account and the exchange rate. Process innovation in the tradable sector leads to a fall in the terms of trade (ToT) and a real appreciation of the exchange rate, expressed as the ratio between domestic and foreign consumer prices. The opposite sign is due to the Balassa-Samuelson effect. This pattern changes with a total factor productivity (TFP) shock in the non-tradable sector. Now, the ToT increases and the real exchange rate depreciates (aside from a short run appreciation). In the case of product innovations, both ToT and the real exchange rate (RER) behave similarly in both cases. However, the composition of the Current Account (CA) varies. With a process innovation in the export sector, both the trade balance and the primary income balance turn negative while product innovations in the FDI sector make the primary balance positive while the trade balance stays negative. We are especially interested in seeing whether the impulse responses to permanent shocks can tell us something about the reasons for persistent external imbalances in countries like Germany and the United States. For the US we find that product innovations originating from US multinationals, at least qualitatively matches well the negative current account and trade balance and a positive primary income balance. The German/Eurozone CA surplus is less easy to explain by technological factors since in our model all technology shocks are associated with persistent CA deficits. Our model confirms what has been shown in previous studies that the German CA is strongly driven by savings. We add to this the observation that increased savings also shows up in an improved primary income balance, which can indeed be observed for Germany.