Work in progress

Macroeconomic Impact of Endemic COVID by Michal Andrle, Liisa T. Laine, Antti Ripatti

Effect of Commuter Train Strike on Mobility and Epidemic by Antti Ripatti


Public funding of banks and firms in a time of crisis

Haavio, Markus; Ripatti, Antti; Takalo, Tuomas (27.06.2022)
We study public funding of banks and non-financial firms in a time of crisis. We find that bank capitalization is more effective in stabilizing the economy than direct funding to firms, but it also creates larger distortions. We show that the optimal, social-welfare-maximizing, structure of a public funding program depends on its size. Small funding programs should target banks while large programs should be directed at non-financial firms.

The Aino 2.0 model

by Juha Kilponen, Seppo Orjasniemi, Antti Ripatti and Fabio Verona
Bank of Finland Discussion Paper 16/2016
This paper presents Aino 2.0 – the dynamic stochastic general equilibrium (DSGE) model currently used at the Bank of Finland for forecasting and policy analysis. The paper provides a detailed theoretical description of the model, its estimation and how it can be used to interpret the evolution of the Finnish economy between 1995 and 2014, including the rise and fall of the electronics industry, the global financial crisis, and the stagnant growth performance since the end of the financial crisis.

Saving Wall Street or Main Street

by Markus Haavio, Antti Ripatti and Tuomas Takalo
Bank of Finland Discussion Paper 12/2016
(This is a revised version of the paper "Macroeconomic Effects of Bank Recapitalizations")

​We build a dynamic stochastic general equilibrium model, where the balance sheets of both banks and non-financial firms play a role in macro-financial linkages. We show that in equilibrium bank capital tends to be scarce, compared with firm capital. We study public funding of banks and firms in times of crisis. Government capital injections can be useful as a shock cushion, but they distort incentives. Small capital injections benefit banks more than firms but the relative benefit is declining in the injection size. Government should first recapitalize banks, and if resources are large enough, lend to firms too.

Macroeconomic Effects of Bank Recapitalizations

by Markus Haavio, Antti Ripatti and Tuomas Takalo

We build a dynamic stochastic general equilibrium model where investments by entrepreneurs and banks can be leveraged by external funding but are subject to a dual moral hazard problem. In our model banks' monitoring investments have a variable scale and real opportunity cost. As a result, the monitoring investments vary over the business cycle which implies that not only the aggregate amount bank capital and entrepreneurial wealth but also their composition matters in the propagation of shocks. We show that in equilibrium bank capital is scarce and that it greatly amplifies the investment shocks but dampens many other type of shocks. We also study capital injections from the government to banks. We show that capital injections can be useful as a shock cushion, but they may be counter-productive if the aim is to avoid deleveraging and to boost investments.

Non-Causal Inflation

by Martin Ellison, Markku Lanne, Antti Ripatti and Pentti Saikkonen

We show that U.S. inflation depends more on the future than on the past in a range of estimated macroeconomic models. This non-causality result is problematic for macroeconomists trained in causal models, since they assume by definition that inflation only depends on current shocks and past information. Even models with rational forward-looking agents are causal as expectations are themselves only a function of the past. Our finding that U.S. inflation data prefers time to run backwards suggests that the models we estimate are misspecified. The focus of this paper is the econometrician's information set. We show that inflation depends more on the future than the past if the information set of the econometrician does not span that of firms in the economy. To combat this missing variable problem we expand the information set of the econometrician to include measures of the output gap, interest rates, and factors identi?ed as principal components of a large dataset of economic indicators. The resulting Phillips curve and factor-augmented vector autoregression models still show strong dependency of U.S. inflation on the future. We therefore conclude that non-causal inflation is pervasive and firms know a lot more about the future than we typically assume.

Estimated DSGE Model of the Finnish Economy: Aino

by Mika Kortelainen and Antti Ripatti

We specify a dynamic stochastic general equilibrium model of the Finnish economy. The model contains nominal frictions in prices and wages and real frictions in the form of habit persistence, investment adjustment costs, and the adjustment costs of import shares. The production relies on the constant elasticity of substitution form in combining capital and labour. This allows us using Harrod-neutral technical change. The monetary policy portrays Finland's small size relative to the euro area. Both the euro area (EUR) and the rest-of-the-world (ROW) interest rates are exogenously given. The foreign exchange rate vis-a-vis euro is fixed. The parameters of the model are estimated with Bayesian methods using the log-linearized version of the model. The Finnish economy portrays surprisingly modest nominal rigidities. Many estimated shock processes show very strong persistence. Model forecast performance is reasonable and is, sometimes, contaminated by the persistent shock processes.

Demographic Uncertainty and Labour Market Imperfections in a Small Open Economy

by Juha Kilponen, Helvi Kinnunen and Antti Ripatti

This paper extends Gertler's (1999) tractable overlapping generations model by allowing for imperfect labour markets and distortionary taxation. Further- more, we allow for stochastic variation in demographic structure. The model is then used to study demographic change in a small open economy of Finland. The simulations highlight a key role played by labour market imperfections in determining a fiscal burden of ageing in defined benefit pensions systems. Higher labour market imperfections lead into considerably stronger responses of labour supply and taxes on ageing. Thus, imperfections magnify the prob- lem associated with .scal sustainability in ageing society. Stochastic simulations suggest that lengthening of working time has rather minor impact on alleviat- ing the fiscal burden of ageing: Only a small fraction of stochastic variation in endogenously determined contribution rate is explained by the stochastic vari- ation in the length of working time. Variation in fertility rate is clearly much more important.

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JEL: E62, E27, H55

Learning to Forecast with a DGE Model

by Juha Kilponen and Antti Ripatti

The Bank of Finland has used a newly built D(S)GE model (Aino model) as its main forecasting tool since August 2004. A common fore- casters’ prejudice is that DSGE models are difficult to use and their data coherence is very low. In this paper we provide contradicting view. We describe the Aino model, its forecasting related modifications, and collect experiences in the use of the model. A succesfull forecasting tool need to digest expert information while retaining its theoretical consis- tency, i.e. it has to incorporate judgement without relaxing story telling features. Aino’s design is based on this prerequisite. It makes use of Harrod neutral technical change within CES aggregators and allow many preference and technology parameters to be time-varying. These choices are key to fullfill practical needs of forecasting with a D(S)GE model.

JEL: E60, C68

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Labour and Product Market Reforms and Fiscal Deficit

by Juha Kilponen and Antti Ripatti

Using a DSGE model of a small open economy we study the response of the economy and income tax rate, in particular, to the reforms in the labour and product markets. The model is non-Ricardian due to the distortionary taxation and built-in life-cycle features. We assume that the wage markup and the price margins are reduced by one per cent each. Both consumption and employment increase permanently. The public sector balances improve, allowing for roughly 1 percentage point cut in labour income taxes. Product market reform leads to a short-run reduction in consumption, leading to an intertemporal tradeoff in reform setting. More activist fiscal policy can dampen this tradeoff.

Key words: competition, dynamic general equilibrium, public finance

JEL classification numbers: E60, C68

This is a substantially revised version of an old discussion paper.

Biased Technical Change and Capital-Labour Substitution in Finland, 1902-2003

by Jukka Jalava (Pellervo Economic Research Institute and Helsinki School of Economics), Matti Pohjola (Helsinki School of Economics and HECER), Antti Ripatti (Bank of Finland) and Jouko Vilmunen (Bank of Finland). HECERTopics in Macroeconomics: Vol. 6: No. 1, Article 8.

The paper argues that a Cobb-Douglas specification may be a reasonable description of the Finnish aggregate production function when a sufficiently long time period (the 20th century) is considered. It is, however, a misleading description of the production technology for the post-WWII period. Controlling for biased technical change, the elasticity of substitution is significantly below one, close to 0.5, during 1945-2003. Given that similar results have been obtained for the U.S. economy, the analysis shows that the value of the elasticity of substitution cannot be dependent on some specific structure of economic institutions but is likely to reflect more general aspects of technology and production. JEL Classification: O3, O4
Keywords: capital-labour substitution, elasticity of substitution, technical change

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Declining Labour Share --- Evidence of a Change in the Underlying Production Technology?

by Antti Ripatti and Jouko Vilmunen (Bank of Finland). Bank of Finland Discussion Paper 10/2001.

The study demonstrates that the decline in the labour share in Finland can not be explained by the Cobb-Douglas production function. Instead, we propose an approach based on the constant-elasticity-of-substitution (CES) production function with labour- and capital-augmenting technical progress. The model is augmented by imperfect competition in the output market. According to the empirical results based on estimation of the first-order-conditions, the technical elasticity of substitution is significantly less than unity (0.6) and hence the Cobb-Douglas production function is rejected. The growth rate of the estimated labour-augmenting technical progress has decreased in recent years, which is not consistent with the 'new-economy' hypothesis. Capital-augmenting technical trend has exploded during the same period, which provides a possible explanation for the rapid growth of the Solow residual. The main contributing factor behind the declining labour share is, however, the increasing mark-up.

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On the Estimation of Euler Equations in the Presence of a Potential Regime Shift

by Pentti Saikkonen (University of Helsinki) and Antti Ripatti (Bank of Finland) Published (2000) in The Manchester School, 68, S1, pp. 92 - 121. Earlier version as the Bank of Finland Discussion Paper 6/99.


The concept of a peso problem is formalized in terms of a linear Euler equation and a nonlinear marginal model describing the dynamics of the exogenous driving process. It is shown that, using a threshold autoregressive model as a marginal model, it is possible to produce time-varying peso premia. A Monte Carlo method and a method based on the numerical solution of integral equations are considered as tools for computing conditional future expectations in the marginal model. A Monte Carlo study illustrates the poor performance of the generalized method of moment (GMM) estimator in small and even relatively large samples. The poor performance is particularly acute in the presence of a peso problem but is also serious in the simple linear case.

Keywords: peso problem, Euler equations, GMM, threshold autoregressive models

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Cointegrated Vector Autoregressive Processes with Continuous Structural Changes

by Antti Ripatti and Pentti Saikkonen, Bank of Finland. Published in (1999) Journal of Business & Economic Statistics, 17, 2, p. 195-205. Revised version of the Bank of Finland Discussion Paper 29/98. Revised in 27 October 1999.


We extend the conventional cointegrated VAR model to allow for general nonlinear deterministic trends. These nonlinear trends can be used to model gradual structural changes in the intercept term of the cointegrating relations. A general asymptotic theory of estimation and statistical inference is reviewed and a diagnostic test for testing the correct specification of an employed nonlinear trend is developed. The methods are applied to Finnish interest rate data. A smooth level shift of the logistic form between the own-yield of broad money and the short-term money market rate is found appropriate for these data. The level shift is motivated by the deregulation of issuing certificates of deposit and its inclusion in the model solves the puzzle of ‘missing cointegration vector’ found in a previous study.

Keywords: cointegrated VAR model, gradual structural change, nonlinear deterministic trend

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Inflation Targeting and the Role of Money in a Model with Sticky Prices and Sticky Money

by Antti Ripatti, Bank of Finland. 6 October 1998, Corrected version of the Bank of Finland Discussion Paper 17/97.


In order to study the role of money in an inflation targeting regime for monetary policy, we compare the interest rate and money as monetary policy instruments. Our dynamic stochastic general equilibrium model combines the money-in-the-utility-function approach with sticky prices. We allow for time-varying preferences for real money balances, ie for velocity shocks and stochastic `technology' shocks in prodution. We show that conditioning the interest rate on the expected future technology change can be used to achieve constant inflation or constant inflation expectations. However, the prediction of technology growth could be a heroic task. The assumed adjustment costs in 'money demand' lead to an equilibrium in which inflation can be controlled by money growth without having information on the current state of the economy. Finally, the tradeoff between money and the interest rate as a monetary policy instrument depends on the parameteric stability of the technology change process relative to that of the 'money demand' function.

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Limited and Full Information Estimation of the Rational Expectations Demand for Money Model: Application to Finnish M1

by Antti Ripatti, Bank of Finland, 6 October 1998. This is a substantially revised version of the Bank of Finland Discussion Paper 3/97.


We compare parameter estimates of the intertemporal money-in-the-utility-function model estimated using the Generalized Method of Moments and Full Information Maximum Likelihood method. The process driving the forcing variables is approximated with vector-autoregression. Both the GMM and FIML parameter estimates are reasonable, and their difference is negligible. This is confirmed by the numerical experiments. However, the standard errors of the parameters differ widely. The cross-equation restrictions implied by the rational expectations hypothesis are clearly rejected, as is typical for these kinds of models; exogeneity restrictions are rejected as well.

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Stability of the Demand for M1 and Harmonized M3 in Finland

by Antti Ripatti, Bank of Finland, 6 October 1998. Paper published in Empirical Economics, Vol 23, Issue 3, 1998.


We derive a theoretical model for the demand for money using the adjustment cost augmented money-in-the-utility-function approach. The steady-state - utility function - parameters of the model of narrow money (M1) estimated with cointegration techniques are stable over the foreign exchange rate regime shift; whereas in the model of harmonized M3 (M3H) they are not stable. The theoretical model fits the M1 data. The adjustment cost parameters of the M1 model describing the dynamics of the demand for money might indicate technological improvements in banking and payments during the sample period. The adjustment cost parameters of the M3H model are not stable. These results suggest that from the Finnish point of view M1 would be a more appropriate intermediate target for monetary policy than harmonized M3.

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Old Stuff


Unpacking Eurosystem Forecasts (joint with Michal Andrle)
Anticipated Fiscal Shocks

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