Nicolai Waldstrøm defends his PhD thesis at the Department of Economics

This Ph.D. thesis consists of four self-contained chapters, which all explore how aggregate business cycle dynamics and stabilization policy are shaped by micro-level heterogeneity in small open economies. The first three chapters focus on household heterogeneity, while the fourth investigates firm heterogeneity.

In the first chapter, written with Jeppe Druedahl, Søren Hove Ravn, Laura Sunder-Plassmann, and Jacob Marott Sundram, we investigate the effects of foreign demand shocks. Empirically, we find that such shocks have significant spillover effects on domestic GDP, employment, and consumption, impacting both tradeable and non-tradeable sectors. We argue that these dynamics are better captured by a Heterogeneous Agent New Keynesian (HANK) model than a Representative Agent (RANK) model. Our analysis shows that monetary policy effectively mitigates these shocks, while fiscal policy is less effective due to asymmetric sectoral effects.

In the second chapter, written with Jeppe Druedahl, Søren Hove Ravn, Laura Sunder-Plassmann, and Jacob Marott Sundram, we analyze the effectiveness of fiscal policy in a small open economy HANK model. While the inclusion of borrowing-constrained agents typically leads to larger fiscal multipliers in closed economies, our findings reveal that the difference between HANK and RANK multipliers diminishes in open economies. This occurs due to leakage effects, where increases in domestic demand leaks abroad, and expenditure switching, which limits the strength of the Keynesian multiplier.

In the third chapter, I investigate the transmission of inflationary shocks in a small open economy HANK model. I demonstrate that redistributive effects of inflation through reduced real wages can be sufficient to generate a domestic contraction. I show that the optimal monetary policy response to inflationary cost-push shocks in a HANK model involves raising interest rates more aggressively than in a RANK model. This is optimal since a large exchange rate appreciation stabilize inflation, real wages, and demand in the HANK model with minimal employment impact.

The fourth chapter, written with Christian Bartels Kastrup, explores how firm heterogeneity shapes the transmission of foreign supply shocks. Using Danish firm-level data, we estimate firm-level responses to increases in import prices, identified using differential trade exposure. We estimate a multi-sector heterogeneous firm model to be consistent with our empirical estimates and show that the inflationary effects of foreign supply shocks are amplified by the presence of larger, material-intensive firms.