Estimating baseline real business cycle models of the Australian economy

This paper is concerned with the issues that arise in building a small Dynamic Stochastic General Equilibrium (DSGE) model of the Australian economy. Our ultimate objective is to build a model that can be used to study long run economic growth and the business cycle. We agree with Cooley and Prescot�s (1995) view that these are phenomena to be studied jointly rather than separately. Adopting this view has several implications for what constitutes the essential components of our a model. We see these as being: a major role for a persistent technology shock in driving economic activity; and consistency with a version of the Ramsey-Cass-Koopmans (RCK) exogenous growth model. Without the former it is not possible to generate realistic business cycle features; demand shocks alone are insuffcient see Harding and Pagan (2007). The RCK exogenous growth model remains the simplest model available to encompass the salient features of economic growth which is why we rate it as essential. We also take the methodological stance that it is desirable to obtain a satisfactory baseline model before adding other desirable features such as: money; openness to international trade, capital flows, and immigration; and price and wage stickiness. In short we see small real business cycle (RBC) models as the natural starting point for our work.Real business cycle; stochastic growth model; technology shock; persistence

The new keynesian approach to dynamic general equilibrium modeling: models, methods, and macroeconomic policy evaluation

This chapter aims to provide a hands-on approach to New Keynesian models and their uses for macroeconomic policy analysis. It starts by reviewing the origins of the New Keynesian approach, the key model ingredients and representative models. Building blocks of current-generation dynamic stochastic general equilibrium (DSGE) models are discussed in detail. These models address the famous Lucas critique by deriving behavioral equations systematically from the optimizing and forward-looking decision-making of households and firms subject to well-defined constraints. State-of-the-art methods for solving and estimating such models are reviewed and presented in examples. The chapter goes beyond the mere presentation of the most popular benchmark model by providing a framework for model comparison along with a database that includes a wide variety of macroeconomic models. Thus, it offers a convenient approach for comparing new models to available benchmarks and for investigating whether particular policy recommendations are robust to model uncertainty. Such robustness analysis is illustrated by evaluating the performance of simple monetary policy rules across a range of recently-estimated models including some with financial market imperfections and by reviewing recent comparative findings regarding the magnitude of government spending multipliers. The chapter concludes with a discussion of important objectives for on-going and future research using the New Keynesian framework

Dynamic models with non clearing markets

Abstract This article studies a new class of models which synthesize the two traditions of general equilibrium with nonclearing markets and imperfect competition on the one hand, and dynamic stochastic general equilibrium (DSGE) models on the other hand. This line of models has become a central paradigm of modern macroeconomics for at least three reasons: (a) it displays solid microeconomic foundations, (b) it is a highly synthetic theory, which combines in a unified framework general equilibrium, nonclearing markets, imperfect competition, growth theory and rational expectations, (c) it is also an empirical success, leading to substantial progress towards matching real world statistics.dynamic stochastic models ; general equilibrium ; non clearing markets ; imperfect competition

Inflation Targeting and the Role of Money in a Model with Sticky Prices and Sticky Money

In order to study the role of money in an inflation targeting regime for monetary policy, we compare the interest rate and money as monetary policy instruments. Our dynamic stochastic general equilibrium model combines the money-in-the utility-function approach with sticky prices. We allow for time-varying preferences for real money balances, ie velocity shocks, and stochastic aggregate costs in production, ie 'technology shocks'. We show that conditioning the interest rate on the expected future cost change can be used to achieve constant inflation or constant inflation expectations. The assumed adjustment costs in 'money demand' lead to an equilibrium in which inflation can be controlled by money growth without information on the current state of the economy. Finally, we discuss the tradeoff between money and the interest rate as a monetary policy instrument. The result depends on the parameter stability of the cost change process relative to that of the 'money demand' function.monetary transmission mechanism; money-in-the-utility-function model; sticky prices; technology shock; monetary policy strategy

A new comparative approach to macroeconomic modeling and policy analysis

In the aftermath of the global financial crisis, the state of macroeconomic modeling and the use of macroeconomic models in policy analysis has come under heavy criticism. Macroeconomists in academia and policy institutions have been blamed for relying too much on a particular class of macroeconomic models. This paper proposes a comparative approach to macroeconomic policy analysis that is open to competing modeling paradigms. Macroeconomic model comparison projects have helped produce some very influential insights such as the Taylor rule. However, they have been infrequent and costly, because they require the input of many teams of researchers and multiple meetings to obtain a limited set of comparative findings. This paper provides a new approach that enables individual researchers to conduct model comparisons easily, frequently, at low cost and on a large scale. Using this approach a model archive is built that includes many well-known empirically estimated models that may be used for quantitative analysis of monetary and fiscal stabilization policies. A computational platform is created that allows straightforward comparisons of models’ implications. Its application is illustrated by comparing different monetary and fiscal policies across selected models. Researchers can easily include new models in the data base and compare the effects of novel extensions to established benchmarks thereby fostering a comparative instead of insular approach to model development

Imperfect competition and sunspots

This paper shows that imperfect competition can be a rich source of sunspots equilibria and coordination failures. This is demonstrated in a dynamic general equilibrium model that has no major distortions except imperfect competition. In the absence of fundamental shocks, the model has a unique certainty (fundamental) equilibrium. But there is also a continuum of stochastic (sunspots) equilibria that are not mere randomizations over fundamental equilibria. Markup is always counter-cyclical in sunspots equilibria, which is consistent with empirical evidence. The paper provides a justification for exogenous variations over time in desired markups, which play an important role as a source of cost-push shocks in the monetary policy literature. We show that fluctuations driven by self-fulfilling expectations (or sunspots) look very similar to fluctuations driven by technology shocks, and we prove that such fluctuations are welfare reducing.Equilibrium (Economics) ; Business cycles

Toward a new paradigm in open economy modeling: where do we stand?

This paper provides a selective, up-to-date survey of the recent, fast-growing literature on new open economy macroeconomics. Lucio Sarno begins with a review of the seminal paper in this literature, describing the baseline model proposed therein. He then covers a number of variants and generalizations of the baseline model involving the allowance for nominal rigidities, pricing to market, alternative preference specifications, and alternative financial markets structures. The author also discusses the recent stochastic extensions of these models, especially focusing on their implications for the link between risk and exchange rates and on new directions for the relevant literature.Econometric models ; Macroeconomics

Extracting Information from the Data: A Popperian View on Empirical Macro

The cointegrated VAR model is proposed as an empirically coherent framework for analyzing macroeconomic phenomena within a dynamic system of pulling and pushing forces. As an illustration we show how an economic theory for inflation and money demand gives rise to a number of hypotheses formulated as testable parameter restrictions on cointegrating relations and common trends. The procedure not only allows us to test prior theoretical hypotheses in a valid maximum likelihood framework but also provides additional empirical results suggesting how to modify or improve our theoretical understanding. The latter is important when theoretical implications fail to hold in the data.cointegrated VAR; inflation; money growth; empirical methodology

Firm-specific capital, nominal rigidities and the business cycle

Macroeconomic and microeconomic data paint conflicting pictures of price behavior. Macroeconomic data suggest that inflation is inertial. Microeconomic data indicate that firms change prices frequently. We formulate and estimate a model which resolves this apparent micro - macro conflict. Our model is consistent with post-war U.S. evidence on inflation inertia even though firms re-optimize prices on average once every 1.5 quarters. The key feature of our model is that capital is firm-specific and predetermined within a period.Business cycles ; Macroeconomics ; Microeconomics