PIK Report No. 102

Most models used in climate economics so far are full-employment models. In Germany, as in other countries suffering from persistent unemployment, climate policy can only be successful if it is embedded in an economic policy that generates additional jobs at a large scale. To investigate the possibility for such embedding, a long-term model of the German economy is needed. lagom sim is such a model. It is a dynamic stochastic general equilibrium model; its dynamics is based on a sequence of temporary equilibria with incomplete markets. The model architecture works without needing the problematic fictions of a macro-economic representative agent or a Walrasian auctioneer. The mechanisms of demand and supply on different markets display the frictions of real markets, where price adjustments take time. First simulation results suggest that it is possible to reduce German unemployment by half in a decade by means of suitable incentives for financial markets. This possibility resembles past experiences of Sweden and Austria. If poorly managed, it would result in a massive increase of greenhouse gas emissions. At the same time, it offers opportunities for a Pareto improving climate policy that combines higher growth with lower emissions. To investigate these opportunities in more detail, further model developments are recommended. The lagom family of models is emerging out of the work of the research group on globalization and financial markets at PIK currently involving A. Biewald, H. Förster, A. Haas, C.Jaeger, J. Krause, F. Meissner, and M. Welp. The help of Rupert Klein in producing lagom sim has been invaluable. Moreover, two sets of ideas on economic dynamics have been particularly inspiring developed by K. Hasselmann at MPI in Hamburg, and by S. Hallegatte and J.-C. Hourcade at CIRED in Paris. Finally, I am grateful to the Potsdam University students attending the course on the German economy in summer 2005 for their curiosity, questions, and comments. Responsibility for errors stays firmly with the author. This document describes lagom sim version 0.1. The model is implemented using the Vensim software for modelling dynamical systems. The code is available from the author upon request. Comments are welcome to [email protected]. lagom is a swedish word denoting a sense of balance and harmony, with a flavor of equilibrium but richer, perhaps akin to the chinese dao. 3