Examining Some Economic Policy Dilemmas with a Structural Model

This article examines the economic policy trade-offs faced by decision-makers using a structural model applied to the Peruvian economy. The research focuses on three scenarios: an increase in domestic productivity, a permanent reduction in public debt while keeping public spending constant, and a permanent decrease in the central bank’s target inflation rate. Using a model that integrates a long-run system with overlapping generations and a short-run system with adjustment costs, a series of simulations is conducted. The results indicate that an increase in productivity leads to higher output without inflationary pressures, while a reduction in public debt—although beneficial in the long run—entails a short-run loss of output, which requires an expansionary monetary policy. Finally, the study reveals that the cost of a disinflationary policy is inversely related to the central bank’s credibility. This analysis offers important implications for the calibration of monetary and fiscal policy in contexts of structural change. (Abstract and audio: Department of Economic Publications)