Nonlinear VAR: Some Theory and an Application to US GNP and Unemployment

A generalization of the endogenous threshold model is developed by extending this class to a multivariate framework and to cases where the feedback acts at multiple lags. The feedback is specified, following Beaudry and Koop, by a variable which measures the depth of recessions. We give conditions for the ergodicity of the model and prove strong consistency of the maximum likelihood estimator, although the objective function is discontinuous in the threshold parameter. The model is applied to a bivariate VAR of output growth and changes in the unemployment rate for the US economy. The nonlinearity is found to be statistically significant only in the unemployment equation and it transmits to GNP through the cross-correlation between the series. We also find that, owing to the nonlinear structure, shocks hitting the economy in downturns have lower persistence than those occurring during expansions. Since this dampening effect is stronger for negative than for positive shocks, the feedback from recessions is found to contribute positively to the long-run growth of the economy and we estimate this contribution to be about 1/6 of the total growth over the sample period. We interpret this result as an empirical validation of those economic theories that model recessions as cleansing times. Finally, we suggest that the state-dependence in persistence is a possible key to interpret the divergence in the measures of persistence existing in the literature.mathematical analysis, stochastic models, United States, unemployment, production, econometric models, estimation of parameters

"Inflation persistence and price-setting behaviour in the euro area: a summary of the Inflation Persistence Network evidence." NBB Working Paper No. 95, October 2006

This paper provides a summary of current knowledge on inflation persistence and price stickiness in the euro area, based on research findings that have been produced in the context of the Inflation Persistence Network. The main findings are: i) Under the current monetary policy regime, the estimated degree of inflation persistence in the euro area is moderate; ii) Retail prices in the euro area are more sticky than in the US; iii) There is significant sectoral heterogeneity in the degree of price stickiness; iv) Price decreases are not uncommon. The paper also investigates some of the policy implications of these findings

Dealing with forward-looking expectations and policy rules in quantifying the channels of transmission of monetary policy

The issue of appraising the transmission process through which monetary policy affects the economy is receiving wider and increasing attention. In Europe, much of the interest in the effects of monetary policy is arguably a reflection of the introduction of the single currency: to the extent that transmission mechanism differ significantly across euro area countries, heterogenous responses of economic activity and prices to the policy instrument should be expected, an occurrence whose policy implications are of major relevance. To gain some insight into the likely causes of those differences recent studies have attempted to identify and assess separately the channels of transmission of monetary policy. This paper proposes a simple methodology to quantify separately the different parts of the overall impulse response that are transmitted through the various mechanisms at play in a model of the economy. It is shown that, under the maintained assumption of linearity, the decomposition of the effects of monetary policy into a number of channels delivered by our approach is exact (i.e., it leaves no unexplained residual). This conclusion holds regardless of the nature of the expectation formation mechanism and the way in which policy decisions are modelled. The features of the proposed approach are illustrated with an empirical application, using a model that features two distinct transmission channels and assumes rational expectations and a monetary policy reaction rule. We show that our approach produces an exact decomposition of the effects of a monetary policy shock. Moreover, and perhaps more interestingly, our approach gives a deeper insight than do standard impulse responses into the specific features of the model that are most relevant in shaping its observed reaction to the shock.Monetary policy transmission channels, decomposition

Is money informative? Evidence from a large model used for policy analysis

In this paper we assess whether monetary variables convey marginal information on the state of the Italian economy, taking as a benchmark the forecasting errors generated by the quarterly model used by the Bank of Italy in the 1990s. We follow two alternative approaches. First we map monetary surprises into estimates of the structural disturbances using a Kalman filter approach, in order to improve the forecasts. Then we look at the sample correlations among forecasting errors in monetary and real variables. We find that bank interest rates have a strong information content. Monetary aggregates play no role according to the first approach; according to the second approach they do, but the sign of their effect is counterintuitive. All in all, the results highlight the role of financial prices and quantities as indicators of the state of the economy but they do not imply a mechanical policy reaction to this information, as both the strength and the sign of the relationship between the surprises in monetary and real variables depend on the source of the shocks.monetary aggregates, information variables, Kalman filter, forecasting

Is money informative? Evidence form a large model used for policy analysis

In this paper we assess whether monetary variables, which are observed with little delay, conveyed marginal information on the state of the Italian economy in the 1990s, taking as a benchmark the forecasting errors generated by the quarterly model used by the Bank of Italy. We follow two approaches. First we map monetary surprises into estimates of the structural disturbances using a Kalman filter approach, in order to improve the forecasts. Then we look at the sample correlations among forecasting errors in monetary and real variables, thereby taking into account links that may not be accounted for by the modelÂ’s structure. We find that bank interest rates have a strong information content. Monetary aggregates play no role according to the first approach; according to the second approach they do, but the economic interpretation of this finding is not straightforward. All in all, the results highlight the role of financial prices and quantities as indicators of the state of the economy. However, they do not imply a mechanical policy reaction to this information, as both the strength and the sign of the relationship between the surprises in monetary and real variables depend on the source of the shocks.monetary aggregates, information variables, Kalman filtering, forecasting

Fast micro and slow macro: can aggregation explain the persistence of inflation?

An aggregation exercise is proposed that aims at in-vestigating whether the fast average adjustment of the disaggregate inflation series of the euro area CPI translates into the slow adjustment of euro area aggregate inflation. We first estimate a dynamic factor model for 404 inflation sub-indices of the euro area CPI. This allows to decompose the dynamics of inflation sub-indices in two parts: one due to a common "macroeconomic" shock and one due to sector specific "idiosyncratic" shocks. Although "idiosyncratic" shocks dominate the variance of sectoral prices, one common factor, which accounts for 30 per cent of the overall variance of the 404 disaggregate inflation series, is the main driver of aggregate dynamics. In addition, the heterogenous propagation of this common shock across sectoral inflation rates, and in particular its slow propagation to inflation rates of services, generates the persistence of aggregate inflation. We conclude that the aggregation process explains a fair amount of aggregate inflation persistence. JEL Classification: E31, E32aggregation and persistence, euro area, Inflation Dynamics

Inflation persistence and price-setting behaviour in the euro area – a summary of the IPN evidence

This paper provides a summary of current knowledge on inflation persistence and price stickiness in the euro area, based on research findings that have been produced in the context of the Inflation Persistence Network. The main findings are - i) Under the current monetary policy regime, the estimated degree of inflation persistence in the euro area is moderate; ii) Retail prices in the euro area are more sticky than in the US; iii) There is significant sectoral heterogeneity in the degree of price stickiness; iv) Price decreases are not uncommon. The paper also investigates some of the policy implications of these findings. JEL Classification: E31, E42, E52.Price setting, inflation persistence, monetary policy, EMU.

How deep are the deep parameters?

Policy evaluation based on the estimation of dynamic stochastic general equilibrium models with aggregate macroeconomic time series rests on the assumption that a representative agent can be identified, whose behavioural parameters are independent of the policy rules. Building on earlier work by Geweke, the main goal of this paper is to show that the representative agent is in general not structural, in the sense that its estimated behavioural parameters are not policyindependent. The paper identifies two different sources of nonstructurality. The latter is shown to be a fairly general feature of optimizing representative agent rational expectations models estimated on macroeconomic data.Structural models, Lucas Critique

Fast micro and slow macro: can aggregation explain the persistence of inflation?

An aggregation exercise is proposed that aims at investigating whether the fast average adjustment of the disaggregate inflation series of the euro area CPI translates into the slow adjustment of euro area aggregate inflation. We first estimate a dynamic factor model for 404 inflation sub-indices of the euro area CPI. This allows to decompose the dynamics of inflation sub-indices in two parts: one due to a commonInflation (Finance) ; Consumer price indexes ; Euro

Long-Run Determinants of Inflation Differentials in a Monetary Union

This paper analyzes the long-run determinants of inflation differentials in a monetary union. First, we aim at establishing some stylized facts relating the regional dispersion in headline inflation rates in the euro area as well as in the main components of the consumer price index. We find that a relatively large proportion of it occurs in the Service category of the EU's harmonized consumer price index (HICP). We then lay out a model of a monetary union with fully flexible prices, the long-run properties of which are analyzed. Our model departs in several respect from the Balassa-Samuelson hypotheses. Our results are in contrast with the result that movements in the real exchange rate are mainly driven by regionally asymmetric productivity shocks in the traded sectors. Our results point instead to relative variations in productivity in the non-traded sector as the primary cause of price and inflation differentials, with shocks to productivity in the traded sector being largely absorbed by movements in the terms of trade in the regional economies. These shocks are also found to largely drive the variability of real wages at the country level.