Model selection for monetary policy analysis – Importance of empirical validity

We investigate the importance of employing a valid model for monetary policy analysis. Specifically, we investigate the economic significance of differences in specification and empirical validity of models. We consider three alternative econometric models of wage and price inflation in Norway. We find that differences in model specification as well as in parameter estimates across models can lead to widely different policy recommendations. We also find that the potential loss from basing monetary policy on a model that may be invalid, or on a suite of models, even when it contains the valid model, can be substantial, also when gradualism is exercised as a concession to model uncertainty. Furthermore, possible losses from such a practice appear to be greater than possible losses from failing to choose the optimal policy horizon to a shock within the framework of a valid model. Our results substantiate the view that a model for policy analysis should necessarily be empirically valid and caution against compromising this property for other desirable model properties, including robustness.Model uncertainty; Econometric modelling; Economic significance; Robust monetary policy.

The Empirical (ir)Relevance of the New Keynesian Phillips Curve

We give an appraisal of the New Keynesian Phillips curve (NPC) as an empirical model of European inflation. We show that existing evidence reported in favour of the NPC on Euro-area and country data is due to a corroborative research strategy. In particular, goodness-of-fit is a weak criterion, since the NPC-fit is well approximated by a random walk. Instead we report the outcome of more critical tests, and the importance of modelling a system that includes the forcing variables as well as the rate of inflation is emphasized.Finally, encompassing tests are applied to open economy versions of the NPC for UK and Norway.New Keynesian Phillips curves; Euro inflation; UK inflation; Norwegian inflation; Monetary policy; Dynamic stability conditions; Evaluation; Encompassing tests

The empirical relevance of the New Keynesian Phillips curve.

The dynamic properties of the The New Keynesian Phillips curve (NPC) is analysed within the framework of a small system of linear difference equations. We evaluate the empirical results of existing studies which uses `Euroland' and US data. The debate has been centered around the goodness-of-fit, but this is a weak criterion since the NPC-fit is typically well approximated by purely statistical models (e.g., a random walk). Several other parametric tests are then considered, and the importance of modelling a system that includes the forcing variables as well as the rate of inflation is emphasized. We also highlight the role of existing studies in providing new information relative to that which underlies the typical NPC. This encompassing approach is applied to open economy versions of the NPC for UK and NorwayNew Keynesian Phillips curves, US inflation, Euro inflation, UK inflation, Norwegian inflation, Monetary policy, Dynamic stability conditions, Evaluation, Encompassing tests.

Econometric Inflation Targeting

Inflation targeting requires inflation forecasts, yet most models in the literature are either theoretical or calibrated. The motivation for this paper is therefore threefold: We seek to test and implement an econometric model forforecasting inflation in Norway–one economy recently opting for formal inflation targeting rather than a managed nominal exchange rate. We also seek to quantify the relative importance of the di?erent transmission mechanisms– with basis in empirical estimates rather than calibrated values. Finally, we want to focus on and exploit econometric issues required in the design and estimation of econometric models used for inflation forecasting and policy analysis.inflation targeting; monetary policy; wages and prices; cointegration; dynamic modelling

Model Specification and Inflation Forecast Uncertainty

Three classes of inflation models are discussed: Standard Phillips curves, New Keynesian Phillips curves and Incomplete Competition models. Their relative merits in explaining and forecasting inflation are investigated theoretically and empirically. We establish that Standard Phillips-curve forecasts are robust to types of structural breaks that harm the Incomplete Competion model forecasts, but exaggerate forecast uncertainty in periods with no breaks. As the potential biases in after-break forecast errors for the Incomplete Competition model can be remedied by intercept corrections, it offers the best prospect of successful inflation forecasting.monetary policy; inflation targeting; wages and prices; model specification; encompassing; model uncertainty; forecasting

MOSES: Model of Swedish Economic Studies

MOSES is an aggregate econometric model for Sweden, estimated on quarterly data, and intended for short-term forecasting and policy simulations. After a presentation of qualitative model properties, the econometric methodology is summarized. The model properties, within sample simulations, and examples of dynamic simulation (model forecasts) for the period 2009q2-2012q4 are presented. We address practical issues relating to operational use and maintenance of a macro model of this type. The detailed econometric equations are reported in an appendix.

Er Norges Banks pengepolitiske modell en god nok modell for norsk økonomi?

Artikkelen er gjengitt med tillatelse fra Samfunnsøkonomenes Forening.Flere økonomer har lenge etterlyst gode alternativer til eksisterende økonometriske modeller for analyser og prognoser på kort- og mellomlang sikt. Anbefalingen fra Norges Bank Watch 2002 om at Norges Bank burde utvikle en moderne makromodell basert på rasjonelle forventninger ble raskt adoptert i Norges Bank, som startet et modellutviklingsprosjekt i 2003. To år senere fikk en pilotversjon av modellen, et system med fire atferdslikninger, status som Norges Banks operative modell for makroøkonomiske analyser. Nylig ble den første fullskala versjonen av modellen lansert under akronymet NEMO (Norwegian Economy Model).1 NEMO er imidlertid ennå ikke operativ i forbindelse med skrivingen av inflasjonsrapportene. I denne kommentaren setter vi derfor søkelys på pilotversjonen, som har representert den modellmessige rammen for pengepolitiske beslutninger i et par år allerede

Den norske modellen for lønnsdannelse : enda viktigere etter ny politikk

Artikkelen er gjengitt med tillatelse fra Samfunnsøkonomenes Forening.Innfasing av oljepenger innebærer høyere lønnsvekst. Et viktig mål for den økonomiske politikken er å hindre at dette gir store omstillinger i norsk økonomi. I denne artikkelen viser vi hvordan Den norske modellen for lønnsdannelse er spesielt godt egnet til å nå et slikt mål. Årsaken er at det da er industrien selv som sitter i førersetet. Om målet nås avhenger således av om Den norske modellen består, men også utøvelsen av pengepolitikken i lys av inflasjonsmålet er viktig i så måte. En alternativ politikk til å tillate høyere lønnsvekst ville nemlig vært en særnorsk renteøkning. Beregninger viser at omstillingene i norsk økonomi i så fall ville kommet langt hurtigere som følge av rentas virkning på valutakursen. Det er da selvfølgelig enda viktigere å bevare Den norske modellen, men det er uvisst om modellen ville overlevd et slikt sjokk

Will it float? The New Keynesian Phillips curve tested on OECD panel data

Abstract: Galí, Gertler and Lòpez-Salido (2005), GGL, assert that the hybrid New Keynesian Phillips curve, NPC, is robust to different choices of estimation procedure and so some forms of specification bias. Specifically, the dominance of forward-looking behavior is robust according to GGL. We assess the NPC on a panel data set from OECD countries and find that the forward rate of inflation dominates also on the panel data set. However, when variables consistent with alternative inflation models are introduced in the models, the forward term is no longer significant. Such an outcome is predicted by the incomplete competition model of inflation, ICM, meaning that the ICM encompasses the NPC. The opposite does not apply. The non-robustness of the OECD panel data NPC is in alignment with a previous encompassing test on euro-area data, as well as tests on data from the UK and from Norway. GGL on their part do not test the robustness of the NPC features with respect to existing inflation models. Keywords: New Keynesian Phillips Curve, forward looking price setting, panel data model, encompassing

Import price formation and pricing to market: A test on Norwegian data

This paper investigates the determinants of Norwegian import prices of manufactures over the period 1970(1) - 1991(4). Multivariate cointegration analysis establishes a long-run relationship between import prices, foreign prices, the exchange rate and domestic unit labour costs. Normalized on import prices, the long-run elasticities are 0.63 (foreign prices and the exchange rate) and 0.37 (domestic costs). Deviations from this relationship are highly significant in a structural import price equation, which also contains positive effects of growth in domestic demand and inflation, as well as a negative effect from the Norwegian unemployment rate. The estimated parameters appear reasonably stable within the sample. Keywords: Import price formation, pricing to market, domestic effects, Johansen procedure, structural error correction model, super exogeneit