The role of expectations in the FRB/US macroeconomic model

In the past year, the staff of the Board of Governors of the Federal Reserve System began using a new macroeconomic model of the U.S. economy referred to as the FRB/US model. This system of mathematical equations, describing interactions among economic measures such as inflation, interest rates, and gross domestic product, is one of the tools used in economic forecasting and the analysis of macroeconomic policy issues at the Board. The FRB/US model replaces the MPS model, which, with periodic revisions, had been used at the Federal Reserve Board since the early 1970s. A key feature of the new model is that expectations of future economic conditions are explicit in many of its equations. Because of this clear delineation of expectations, the FRB/US model can be used to study issues that would be difficult or impossible to study with the MPS model. For example, the new model can show how the economy's response to specific events, such as a reduction in defense spending, may vary considerably with the speed at which the public recognizes that the event has occurred or will occur.Econometric models ; Federal Reserve System ; Forecasting

Nominal Income Targeting with the Monetary Base as Instrument: An Evaluation of McCallum\u27s Rule

In this paper, we explore McCallum\u27s monetary base instrument rule in the context of several models. The first section uses two models, previously utilized by McCallum, to demonstrate the general properties of his rule and to update through 1992 the empirical support for the rule. The second section uses models that allow a significant role for interest rates in transmitting the effects of changes in the monetary base to aggregate demand. The analysis in these two sections makes two main points: (1) Shifts. or instabilities, in the structural relationship between the base and nominal GNP in the 1980s and 1990s raise questions about the efficacy of the proposed rule; and (2) The ability of McCallum\u27s base instrument rule to control nominal output depends on the response pattern of the target variable, nominal output, to changes in the base. In the sequence of models presented, we lay out these dynamic linkages in successively more detail and examine their ·implications for nominal income targeting

Prices, Wages, and Employment in the U.S. Economy: A Traditional Model and Tests of Some Alternatives

In this paper, we outline the cost minimizing behavior of oligopoly firms and the price adjustment process in the labor market which underlie the traditional formulation of aggregate wage-price behavior in the U.S., and show that resulting equations applied to U.S. data remain stable before and after the significant change in the monetary policy rule that had taken place in 1979. This result contradicts the prediction of the Lucas critique applied to this context that, in response to a major change of the monetary policy rule, the Phillips curve and the price setting equation of firms would have undergone significant changes. We test several competing hypotheses for the price level determination, including the possibility that more direct effect of the money supply should be relevant, and show that our formulation dominates alternatives in non- nested tests. Finally, we present evidence that the nature of capital is putty-clay rather than fully malleable, together with a demand function for labor based on this recognition. In the process of these inquiries, we contrast our formulation with that proposed by Layard and Nickell in England.

Two practical algorithms for solving rational expectations models

This paper describes the E-Newton and E-QNewton algorithms for solving rational expectations (RE) models. Both algorithms treat a model's RE terms as exogenous variables whose values are iteratively updated until they (hopefully) satisfy the RE requirement. In E-Newton, the updates are based on Newton's method; E-QNewton uses an efficient form of Broyden's quasi-Newton method. The paper shows that the algorithms are reliable, fast enough for practical use on a mid-range PC, and simple enough that their implementation does not require highly specialized software. The evaluation of the algorithms is based on experiments with three well-known macro models--the Smets-Wouters (SW) model, EDO, and FRB/US--using code written in EViews, a general-purpose, easy-to-use software package. The models are either linear (SW and EDO) or mildly nonlinear (FRB/US). A test of the robustness of the algorithms in the presence of substantial nonlinearity is based on modified versions of each model that include a smoothed form of the constraint that the short-term rate of interest cannot fall below zero. In two single-simulation experiments with the standard and modified versions of the models, E-QNewton is found to be faster than E-Newton, except for solutions of small-to-medium sized linear models. In a multi-simulation experiment using the standard versions of the models, E-Newton dominates E-QNewton.Rational expectations (Economic theory)

Structure and uses of the MPS quarterly econometric model of the United States

Econometric models ; Forecasting

The evolution of macro models at the Federal Reserve Board

� This paper was prepared for the Carnegie-Rochester Conference on Public Policy, November 22-23, 1996. The authors gratefully acknowledge the comments of Robert King and Ben McCallum and participants at the conference. The macroeconomic models at the Federal Reserve Board described in this paper represent the work of many individuals at the Fed. Brayton and Williams participated in the project to build the FRB/US model, along with other members of the Macroeconomics and Quantitative Studies section in the Division of Research and Statistics. They would like to acknowledge the valuable assistance of Steve Sumner in preparing this paper. The FRB/MCM was developed in the Trade and Financial Studies section of the Division of International Finance. Levin and Tryon acknowledge valuable discussions with David Bowman, Chris Erceg, Dale Henderson, and John Rogers, and the excellent research assistance of Asim Husain and Jon Otting. Views presented are those of the authors and do not necessarily represent those of the Federal Reserve Board.

Nominal income targeting with the monetary base as instrument: an evaluation of McCallum's rule

Monetary policy - United States ; Income ; Money supply