Bayesian Estimation of DSGE Models: Is the Workhorse Model Identified?

Koop, Pesaran and Smith (2011) suggest a simple diagnostic indicator for the Bayesian estimation of the parameters of a DSGE model. They show that, if a parameter is well identified, the precision of the posterior should improve as the (artificial) data size T increases, and the indicator checks the speed at which precision improves. It does not require any additional programming; a researcher just needs to generate artificial data and estimate the model with different T. Applying this to Smets and Wouters'(2007) medium size US model, we find that while exogenous shock processes are well identified, most of the parameters in the structural equations are not.Bayesian Estimation, Dynamic stochastic general equilibrium models, Identification.

Population Aging and Potential Growth in Asia

We study the effects of projected population aging on potential growth in Asian economies over the period 2015–2050. We find that an increase in the share of the population over 64 years of age will significantly lower output growth through decreased labor participation. Population aging can also reduce economic growth through increased labor income taxes and dampened productivity growth

Inventories in Dynamic General Equilibrium

This article investigates a dynamic general equilibrium model with a stockout constraint, which means that no seller can sell more than the inventories that she has. The model successfully explains two inventory facts; (i) inventory investment is procyclical, and (ii) production is more volatile than sales. The key intuition is that, since inventories and demand are complements in generating sales, the optimal level of inventories is increasing in expected demand. Thus, when demand is expected to be strong, firms increase their production not only to meet their demand but also to accumulate inventories. Also, our model shows that the inventory to sales ratio is persistent and countercyclical, while the (endogenous) markup is countercyclical. These are because a high interest rate in booms discourages firms to hold inventories

Inventories in general equilibrium dynamics.

This thesis analyses inventories empirically and theoretically. Inventories are important in miderstanding business cycles, not only because inventory investment accounts for a large share of GDP growth rate. This thesis also emphasises the cyclicality of inventories. Often, business cycles are regarded as exponential decays, i.e., successive deviations from the steady state and their returning processes. In contrast, this thesis offers a battery of evidence that economic variables, such as sales and inventories, follow damping oscillations, i.e., stable sine waves. This means that a boom is the seed of the recession that follows, and vice versa. This thesis also reveals inventories' role in such endogenous cycles. The first chapter presents empirical evidence of periodicity. VAR estimations find evidence of sine waves - namely, complex roots. Indeed, the detected complex roots seem to capture the actual business cycles; the estimated lengths of one business cycle are close to those of the post-war average in both Japan and the United States. This chapter also shows that peaks and bottoms of inventories lag behind those of production; such a time lag is called a phase shift. In addition, this chapter finds that the U.S. Federal Reserve anticipates inventory cycles, while the Bank of Japan does not. The second chapter constructs a theoretical model with a stockout constraint and a production chain in the rational dynamic general equilibrium framework, which quantitatively satisfies stylised inventory facts. Importantly, the model successfully mimics observed inventory cycles. Moreover, working hours are more volatile and the correlation between labour productivity and output is lower than in the standard real business cycle model. Finally, the third chapter offers a solution algorithm for linear rational expectation models under imperfect information. Inventories are closely related to imperfect information, and inventories are often regarded as buffers against unobserved demand shocks

Trend Dominance in Macroeconomic Fluctuations

This paper investigates multivariate Beveridge-Nelson decomposition of key macro aggregate data. We find (a) inflation seems to be dominated by its trend component, and, perhaps as a result of this, the short-term interest rate is also trend dominated; and (b) consumption also seems to be dominated by its trend component perhaps as the permanent income hypothesis suggests. What is new here is that, although the difficulty of rejecting a unit root for these variables has been long recognized, we show that these unit root processes account for a large share of the variable fluctuations. This result raises a concern about the convention that the non-stationary data is detrended in standard DSGE-type structural estimation, in the sense that a significant portion of data variation actually may come from the trend components

A Simple Model of Growth Slowdown

This paper studies a simple endogenous growth model to explain growth slowdowns. It is designed to explain, for example, the middle income trap often observed in the south-east Asian countries, the U.K.'s productivity puzzle after the Great Recession and the lost decades of Japan in a unified framework. It is based on the Romer's (1990, JPE) variety expansion model with additional state variable, which we call the R&D environment. The R&D environment is a sort of social capital that captures the research network and culture, society's attitude towards research activities, and so on. Together with the non-negativity constraint of the labour supply, this additional state variable generates multiple steady states (balanced growth paths, BGPs). The model has three BGPs, of which the middle one is unstable (explosive) while the other two satisfy the saddle path stability with high and low R&D activities. Without stochastic shocks, the model exhibits strong initial state dependency, meaning that even only small difference in the initial state could lead to a large difference in the long-run. With stochastic shocks, occasional shifts between two stable BGPs can occur. The model offers an intuitive explanation why a financial shock is particularly important for growth slowdowns. Interestingly, before a growth slowdown, a financial malfunctioning raises the stock return. Finally, our model is fairly realistic in the sense that it allows us to do calibration exercises which are rather standard in the business cycle studies

A Solution Method for Linear Rational Expectation Models under Imperfect Information

This article presents a solution algorithm for linear rational expectation models under imperfect information, in which some decisions are made based on smaller information sets than others. In our solution representation, imperfect information does not affect the coefficients on crawling variables, which implies that, if a perfect-information model exhibits saddle-path stability, for example, the corresponding imperfect-information models also exhibit saddle-path stability. However, imperfect information can significantly alter the quantitative properties of a model. Indeed, this article demonstrates that, with a predetermined wage contract, the standard RBC model remarkably improves the correlation between labor productivity and output

Population Aging, Government Policy and the Postwar Japanese Economy

This paper analyzes the Postwar Japanese economy with a parsimonious neoclassical growth model that incorporates the demographic transition in Japan. We find that i) productivity growth is the most important driver of the postwar economic growth, ii) the workweek reduction policy of the 1990s significantly reduced Japanese output. iii) the increase in the fraction of the population aged above 65 years old significantly reduced output relative to its potential through the decline in the employment rate and the increase in payroll tax

Bayesian Estimation of DSGE models: Identification using a diagnostic indicator

Koop, Pesaran and Smith (2013) suggest a simple diagnostic indicator for the Bayesian estimation of the parameters of a DSGE model. They show that, if a parameter is well identified, the precision of the posterior should improve as the (arti…cial) data size T increases, and the indicator checks the speed at which precision improves. As it does not require any additional programming, a researcher just needs to generate artificial data and estimate the model with increasing sample size, T. We apply this indicator to the benchmark Smets and Wouters’(2007) DSGE model of the US economy, and suggest how to implement this indicator on DSGE models

A General Equilibrium Model of Environmental Option Values

In this paper we consider the option value of the environment employing a stochastic general equilibrium growth model. In our model, as in existing studies, because of irreversibility, the environment has significant real option value. However, unlike the existing literature, the value of the environment is endogenously determined in our general equilibrium setting. In our model, the elasticity of substitution between the environment and consumption not only has quantitative effects but also qualitative effects on the option value of the environment and the optimal allocation of land. We also show that the volatility of the exogenous shock process has quantitatively significant effects on the size of the option value which has important implications for the practical estimation of environmental option values