IGEM – Italian General Equilibrium Model

IGEM is a medium scale Dynamic General Equilibrium (DGE) model for the Italian economy developed at the Department of Treasury of the Italian Ministry of the Economy and Finance and currently managed at Sogei S.p.A. (IT Economia - Modelli di Previsione ed Analisi Statistiche) . The model, which is based on explicit microeconomic foundations, has been designed to study the impact and the propagation mechanism of temporary shocks and to evaluate alternative reform scenarios, single policy interventions and fiscal consolidation packages.

IGEM is a New Keynesian (NK) model that features a large assortment of nominal and real frictions. Specifically, the model features two nominal frictions, convex costs on price and wage adjustment, and four sources of real rigidities, investment adjustment costs, variable capital utilization, external habit in consumption, and imperfect competition in product and labour markets. All these frictions are necessary to create plausible short-run dynamics, consistently with what we observe in the data.

The skeleton of the model consists of an open economy taking as given the world interest rate, world prices and world demand with four types of economic agents: households, firms, a monetary authority and fiscal authority, both adopting rule-based stabilization policies. Contrary to most NK- DGE models, IGEM features a detailed labour market in which different contract types coexist, so to better describe the Italian economy, whose labour market is heterogeneous. This heterogeneity in the labour market, coupled with a high degree of real and nominal rigidities, reveals to be essential in explaining the transmission mechanisms and the effects on employment and income of the business cycle and of different policy interventions.

Specifically, the labour force in IGEM is divided in three categories: (i) employees (skilled and unskilled) with a stable contract of employment; (ii) atypical workers who have flexible working patterns, such as temporary workers, homeworkers and those who are in short-term contracts; (iii) self-employed workers who may supply work under a contract for services.

Hiring and firing those who are qualified as employees entail high adjustment costs. Similarly, the degree of nominal wage stickiness is much higher for employees as well as their market power. By contrast, atypical workers who often fail to qualify for employment protection rights, have low hiring and firing costs and no market power. Together with self-employed workers they represent the more volatile component of the workforce, more subject to the effects of business cycle fluctuations.

This heterogeneity in the labour market allows to include into the model a large battery of fiscal instruments (different labour tax rates, subsidies and social security contribution rates) opening up to the possibility of exploring the effects of several fiscal reforms aimed at increasing employment, favoring social inclusion and reducing inequalities.

Consistently with a widespread practice in the NK literature, IGEM incorporates two types of households: the Ricardian households who have access to financial markets, accumulate physical capital and are so able to smooth their consumption profile in response to shocks, and the non Ricardian households who cannot trade in financial markets and accumulate capital so that their consumption is a function of their disposable income (the so called “hand to mouth” consumers). This heterogeneity of households is strictly related to that considered in the labour market. In fact, it is assumed that Ricardian households supply labour services as employees and self-employed workers, while non Ricardian consumers supply labour services as atypical workers only. Intuitively, workers with stable contracts have an easy access to credit, while atypical workers with flexible labour patterns are more likely to be liquidity constrained.

Despite its complexity, IGEM has a highly flexible structure which allows the model to be adapted easily to the nature of the issue under investigation. All these features, together with the richness of policy instruments, make of IGEM a useful simulation tool of analysis.