Intertemporal Substitution in Macroeconomics: Evidence from a Two-Dimensional Labour Supply Model with Money

The hypothesis of intertemporal substitution in labour supply has a history of empirical failure when confronted with aggregate time-series data. The authors show that a two-dimensional labour supply model, adapted to an environment with money as originally proposed by Lucas and Rapping (1969) and Lucas (1972), performs very well. The overidentifying restrictions implied by the model are far from rejected. The estimated parameters of preferences are generally stable and meaningful. Furthermore, the estimated wage elasticities of labour supply are much higher than previously found in the literature.Business fluctuations and cycles; Labour markets; Econometric and statistical methods

Forecasting with the New-Keynesian Model: An Experiment with Canadian Data

This paper documents the out-of-sample forecasting accuracy of the New Keynesian Model for Canadian data. We repeatedly estimate the model over samples of increasing lengths, forecasting out-of-sample one to four quarters ahead at each step. We then compare these forecasts with those arising from an unrestricted VAR using recent econometric tests. We show that the accuracy of the New Keynesian model's forecasts compares favourably to that of the benchmark. The principle of parsimony is invoked to explain these resultsout-of-sample forecasting ability, estimated DGSE models

Monetary Policy in an Estimated DSGE Model with a Financial Accelerator

This paper estimates a sticky-price DSGE model with a financial accelerator to assess the importance of financial frictions in the amplification and propagation of the effects of transitory shocks. Structural parameters of two models, one with and one without a financial accelerator, are estimated using a maximum-likelihood procedure and post-war US data. The estimation and simulation results provide some quantitative evidence in favour of the financial accelerator model. The financial accelerator appears to play an important role in investment fluctuations, but its importance for output depends on the nature of the initial shockMonetary policy, Financial accelerator, DSGE estimation

Bank Lending, Credit Shocks, and the Transmission of Canadian Monetary Policy

The authors use a dynamic general-equilibrium model to study the role financial frictions play as a transmission mechanism of Canadian monetary policy, and to evaluate the real effects of exogenous credit shocks. Financial frictions, which are modelled as spreads between deposit and loan interest rates, are assumed to depend on economic activity as well as on credit shocks. A general finding is that almost all of the real response to a monetary policy shock comes from the price rigidity and not the credit frictions. Credit shocks, however, do have substantial real effects on macroeconomic variables. Thus, in this model, imperfections in credit markets are responsible only for a small amplification and propagation of the real effects of monetary policy shocks.Financial institutions; Monetary policy framework; Transmission of monetary policy

Forecasting Canadian Time Series with the New Keynesian Model

The authors document the out-of-sample forecasting accuracy of the New Keynesian model for Canada. They estimate their variant of the model on a series of rolling subsamples, computing out-of-sample forecasts one to eight quarters ahead at each step. They compare these forecasts with those arising from simple vector autoregression (VAR) models, using econometric tests of forecasting accuracy. Their results show that the forecasting accuracy of the New Keynesian model compares favourably with that of the benchmarks, particularly as the forecasting horizon increases. These results suggest that the model could become a useful forecasting tool for Canadian time series. The authors invoke the principle of parsimony to explain their findings.Business fluctuations and cycles; Economic models; Econometric and statistical methods

Optimal Taylor Rules in an Estimated Model of a Small Open Economy

The authors compute welfare-maximizing Taylor rules in a dynamic general-equilibrium model of a small open economy. The model includes three types of nominal rigidities (domestic-goods prices, imported-goods prices, and wages) and eight different structural shocks. The authors estimate the model's structural parameters by maximum likelihood using Canadian and U.S. data, and use a second-order approximation of the model to measure the welfare effects of different Taylor rules. By estimating the model, the authors can compare welfare levels with that attainable under the Taylor rule estimated for their sample period. They find that the welfare gains from moving to the optimal Taylor rule are larger than those obtained by previous researchers.Economic models; Exchange rates; Inflation targets

Optimal Taylor Rules in an Estimated Model of a Small Open Economy

We develop a model of a small open economy with three types of nominal rigidities (domestic goods prices, imported goods prices and wages) and eight different structural shocks. We estimate the model's structural parameters using a maximum likelihood procedure and use it to compute welfare-maximizing Taylor rules for setting domestic short-term interest rates. For these computations, we use a second-order approximation around the model's deterministic steady state, which allows the Taylor rule coefficients to affect the means of consumption, leisure and real balances as well as their variances. Welfare gains from moving to the optimal Taylor rule are substantial, but require a very precise knowledge of the values of the model's structural parameters.Economic models; Open economy; Optimal monetary policy; Taylor rules

Canada's Pioneering Experience with a Flexible Exchange Rate in the 1950s: (Hard) Lessons Learned for Monetary Policy in a Small Open Economy

This paper revisits Canada's pioneering experience with floating exchange rate over the period 1950–1962. It examines whether the floating rate was the best option for Canada in the 1950s by developing and estimating a New Keynesian small open economy model of the Canadian economy. The model is then used to conduct a counterfactual analysis of the impact of different monetary policies and exchange rate regimes. The main finding indicates that the flexible exchange rate helped reduce the volatility of key macroeconomic variables. The Canadian monetary authorities, however, clearly did not understand all of the implications of conducting monetary policy under a flexible exchange rate and a high degree of capital mobility. The paper confirms that monetary policy was more volatile in the post-1957 period and Canada's macroeconomic performance suffered as a result.Exchange rates; Economic models