The Central Bank of Malta has developed a Dynamic Stochastic General Equilibrium Model (DSGE) for Malta, named MEDSEA (Malta's Elementary DSGE - A Small open economy in the EA). This model was developed following a three-year technical cooperation with Banca d'Italia.

The model is similar in nature to other small open economy models and contains a number of nominal and real frictions that allow the model to replicate the sluggish reaction of economic variables documented in empirical research. Unlike traditional models, all mathematical equations in this framework are strictly derived from economic theory under the assumption of rational and forward-looking expectations. MEDSEA is thus able to allow for the anticipatory behaviour of the households and firms operating in the economy.

MEDSEA contains key modifications designed to account for Malta's specific characteristics. The model distinguishes between a tradable and non-tradable sector that reflects the different nature of exports when compared to other production meant for domestic use. The model features distribution costs in the export sector, therefore allowing a wedge to exist between wholesale and retail export prices. In light of Malta's membership in a monetary union, MEDSEA includes an exogenously set nominal interest rate and exchange rate. The model is calibrated in order to match the key ratios observed in Maltese data.

In 2017, MEDSEA was extended with a detailed fiscal block. On the government revenue side, Ricardian equivalence is broken by the presence of distortionary taxes on consumption, labour income and capital income. On the expenditure side, the government uses public labour and purchases of goods and services to produce public goods that enter the utility function of private households, thereby introducing a trade-off between welfare enhancing public goods and the misallocation of labour and goods induced by government expenditure. This extension allows for an in-depth analysis of the effects of changes in government expenditure and investment as well as in the tax regime of the Maltese economy in a theoretically consistent way.

In 2020, staff in Research Department have extended MEDSEA with housing and credit frictions. This extension provides a role for macro-prudential policy, through the implementation of counter-cyclical policy, to respond to excessive rise in economy-wide leverage. 

MEDSEA, together with its future extensions, is meant to be used as a complement to existing policy analysis tools available at the Central Bank of Malta.

MEDSEA: A small open economy DSGE model for Malta

MEDSEA: A small open economy DSGE model for Malta with fiscal extension

MEDSEA-FIN: A small open economy DSGE model for Malta with housing and financial frictions

Studies using MEDSEA:

The macroeconomic effects of closing the public sector capital gap in Malta

The macroeconomic effects of efficiency gains in electricity production in Malta