LOLA 3.0: Luxembourg OverLapping generation model for policy analysis: Introduction of a financial sector in LOLA

LOLA 2.0 is a dynamic general equilibrium model for the Luxembourg economy, which features overlapping generation dynamics, labormarket frictions à la Diamond-Mortensen- Pissarides and a New Open Economy Macroeconomics structure. This paper presents the model LOLA 3.0, which essentially integrates a financial sector to LOLA 2.0. In contrast to the existing dynamic stochastic general equilibrium (DSGE) literature, the financial sector does not intermediate between resident households and resident firms, but exports wealth management services. We calibrate the model to match the size of the financial sector in terms of employment, value added, net exports and taxes. The 2008 financial crisis has affected Luxembourg’s financial sector and slowed inflows of cross-border workers. Because there is a lot of uncertainty surrounding future growth of the Luxembourg financial sector and cross-border worker inflows, we use LOLA 3.0 to study the evolution of the Luxembourg economy between 2015 and 2060 under alternative scenarios (high – medium – low).

Keywords: Overlapping generations, Long-run projections, Financial sector, Luxembourg.

JEL-Code: D91, E24, E62, F41, J11.