Dear all,

We recently got our simulation of Galí, López-Salido & Vallés (2007) to work (see Gali_2007_v2.mod (2.7 KB) )

Thanks to prof. Pfeifer for guidance in that!

We are now interested in adding a Covid-like shock to the model, but we are struggling with where in the linearized model our shocks should appear.

We qualitatively wanted a simultaneous negative supply- and demand-shock, such that both production, consumption and more crucially also inflation, wages and labor hours decrease.

This is seemingly more difficult than we expected.

We thought of a simultaneous shock to labor disutility (decreasing labor supply, aggregate demand and thus inflation), combined with a negative shock to labor productivity (decreasing supply and labor demand - and thus wage).

We do realize that we thus shock in dual directions in terms of price-levels in both the goods- and labor markets.

The concrete shocks we are trying to include are:

Decrease to z in the production function: Y = K^alpha * (zN)^(1-alpha)

Increase to z in the utility function: U = lnC - ((zN)^(1+varphi))/(1+varphi)

We expect the shocks to hit (and have marked in the code):

- Production function (decrease in production)
- Wage equation from consumers’ N-FOC (we expect unions to demand a higher wage per N / lower N given wage). Here, we include z with a (1+varphi) as we do not expect consumers to take the shock into account when maximizing utility.
- Euler equation (together with - and with same effect as N)

We are unsure as to whether it should also shock firms’ markups - as their costs from labor are now relatively higher than before, and we want to model the decrease in labor **demand**.

We know this might be a long shot - but assumed this forum would be the best to go to.

Do anyone have experience with negative demand-shocks to this type of linearized DSGE with imperfect labor markets and HTM-consumers? Other shocks yielding the same negative effect to inflation, output, wages and hours are very welcome as well.

Thanks!