Flexibility in design: the multiple applications of a medium-sized empirical model for Denmark

In this paper, we present QMDE, an empirical quarterly stock-flow consistent (SFC) model of Denmark. It is categorized as a medium-sized model to strike a balance between complexity and economic intuition. This model provides a nuanced understanding of Denmark’s economic structure, segmenting it into five institutional sectors and analysing transactions and financial flows among them. The model operates on a demand-led framework, focusing on the main components of aggregate demand influencing real GDP. It details the determinants of consumption, investment, profit share, capacity utilization and international trade flows, using data from Denmark to estimate structural parameters with an autoregressive distributed lag (ARDL) approach. QMDE’s versatility is demonstrated through four applications. First, it is used to examine whether Denmark’s economy is wage-led or profit-led. The model processes various policy shocks, showing complex relationships between demand, income distribution and economic growth. The results suggest that Denmark does not strictly conform to being either wage-led or profit-led. Second, addressing inflationary pressures post-COVID-19, the model assesses the efficacy of traditional monetary responses and explores alternative fiscal and income policies. The analysis suggests that coordinated tax reductions and wage-price policies effectively mitigate inflation, while supporting GDP growth. Third, analysing the increase in the surplus level of Denmark’s current account after 2010, the model identifies key drivers such as increased real net exports and favourable terms of trade. Counterfactual scenarios reveal that changes in trade balances, export prices and savings rates significantly impact the current account balance, suggesting a shift towards a more permanently high surplus. Fourth, investigating the effects of tightening of unemployment benefits under Denmark’s flexicurity model, the model evaluates scenarios of policy reversal, the removal of unemployment benefits’ role in wage determination and changes in unemployment insurance membership. Findings indicate an overall expansionary but modest effect of unemployment benefits on economic growth and employment, highlighting a policy trade-off between fiscal savings and employment stimulation.