The role of agent heterogeneity on the demand-side in the DSGE framework

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Heterogeneities, the differences between agents, firms and institutions, are common characteristics of economies, rich and poor. If heterogeneities are ubiquitous in economies, serious dynamic models used for policy analysis and forecasts should account for these. Common Dynamic Stochastic General Equilibrium (DSGE) models single out the behaviours of representative agents', and thus remain silent on how fiscal and monetary policy decisions affect economic inequalities. We will investigate The role of agent heterogeneity on the demand-side in the DSGE framework. By introducing a tractable model with heterogeneities, this thesis shall put forward a framework that will provide insights into the links between monetary and fiscal policy, heterogeneities in labour markets and financial markets, and economic inequality. The model shall provide evidence on whether heterogenous agent models can produce consistent results with the data, particularly about economic inequality. This thesis will introduce building blocks to innovate the heterogenous agent framework, formulating a model that captures agents with differing skills and access to financial goods. Chapter 1 Question What does financial market heterogeneity mean for the effectiveness of monetary and fiscal policy? It has been observed that some countries that focus on investing in output-producing assets have grown faster economically than countries that choose more liquid, yet far less important in the output-production process, investment vessels. This chapter shall construct a model with households under the existence of fiscal and monetary authority and nominal rigidities. One household shall have access to invest savings into productive, output-producing assets, capturing long-term productive assets, and sell financial assets, assets unrelated to production, capturing short-term financial assets, to the other household. The other household invests savings into these financial, non-output-producing assets. An important distinction is that these productive and unproductive assets are imperfect. In such a DSGE framework, this chapter will propose a novel model that captures the interactions between heterogeneous agents, nominal rigidities, and fiscal and monetary policy roles on short-run economic inequality dynamics. Chapter 2 shall move the thesis's focus away from financial markets and toward heterogeneity in labour markets. The question it shall answer is How do agent heterogeneities in the labour market affect unemployment under differing fiscal and monetary regimes? The heterogeneous agent model in chapter two shall capture two utility-maximising households, under fiscal and monetary authorities, that consume goods, leisure and savings. One household shall be modelled as more skilled than the other. Such an approach shall generate results on changes in labour supply behaviour under government support, inflation and extreme black swan phenomena like a pandemic under rigidities. Chapter 3 shall bring Chapters 1 and 2 together in a larger-scale heterogeneous agent DSGE model with heterogeneity in financial market access and labour market participants. Such a model captures financial and labour market agent heterogeneity, allowing us to generate predictions consistent with the data and analyse heterogeneous behaviour and economic inequality in response to shocks. Modelling approaches moving away from the representative agent framework, which embraces and captures the existence of agent heterogeneities, shall generate richer results on how different households respond to shocks subjected to the economy, particularly highlighting how inequalities in labour and financial markets change when active fiscal and monetary policy is applied in a locked-down economy. Such a novel modelling approach capturing multiple heterogeneities shall provide a tool for better-informed fiscal and monetary policymaking.