Persistence Endogeneity Via Adjustment Costs: An Assessment based on Bayesian Estimations

This paper estimates a dynamic stochastic general equilibrium (DSGE) model for the European Monetary Union by using Bayesian techniques. A salient feature of the model is an extension of the typically postulated quadratic cost structure for the monopolistic choice of price variables. As shown in Sienknecht (2010a), the enlargement of the original formulation by Rotemberg (1983) and Hairault and Portier (1993) leads to structurally more sophisticated inflation schedules than in the staggering environment by Calvo (1983) with rule-of-thumb setters. In particular, a desired lagged inflation term always arises toghether with a two-period-ahead expectational expression. The two terms are directly linked by a novel structural parameter. We confront the relationships obtained by Sienknecht (2010a) against European data and compare their data description performance against the widespread extension of the Calvo setting with rule-of-thumb behavior.Bayesian, Simulation, Indexation, Model Comparison

Which Parameters Drive Approximation Inaccuracies?

This paper identifies parameters responsible for welfare reversals when the basic New Keynesian model is approximated. In our setting, a reversal occurs when the Ramsey policy under timeless perspective commitment ceases to be dominant against the Taylor rule after approximating the model. We find that the parameters involved are the degree of persistence in the autoregressive shock process and the labor elasticity of real output.Optimal Monetary policy, Approximations, Welfare Analysis, Timeless Perspective

On the informational loss inherent in approximation procedures: Welfare implications and impulse responses

This paper shows the inappropriatedness of approximation procedures for welfare rankings across suboptimal policy strategies. On the grounds of a simple general equilibrium model, we find that even commonly accepted techniques are not suitable to achieve accurate welfare orderings. This result points to a non-universality of these methods since we unveil welfare reversals when we compare them with the implications of the corresponding Ramsey problem. We infer that the spurious outcomes originate from restricting the approximations to only first and second-order moments. The order of approximation needed to obtain accuracy obviously depends on the underlying type of general equilibrium model and on its parameter values. But this creates uncertainty about the correct degree of approximation adopted by researchers in order to obtain clear welfare insights. Therefore, we strongly recommend that normative analyses should rely exclusively on the exact optimality conditions delivered by the Ramsey problem. Nonetheless, we are able to propose approximation methods in order to characterize macroeconomic fluctuations triggered by small disturbances

Which parameters drive approximation inaccuracies?

This paper identifies parameters responsible for welfare reversals when the basic New Keynesian model is approximated. In our setting, a reversal occurs when the Ramsey policy under timeless perspective commitment ceases to be dominant against the Taylor rule after approximating the model. We find that the parameters involved are the degree of persistence in the autoregressive shock process and the labor elasticity of real output

Persistence endogeneity via adjustment costs: An assessment based on Bayesian estimations

This paper estimates a dynamic stochastic general equilibrium (DSGE) model for the European Monetary Union by using Bayesian techniques. A salient feature of the model is an extension of the typically postulated quadratic cost structure for the monopolistic choice of price variables. As shown in Sienknecht (2010a), the enlargement of the original formulation by Rotemberg (1983) and Hairault and Portier (1993) leads to structurally more sophisticated inflation schedules than in the staggering environment by Calvo (1983) with rule-of-thumb setters. In particular, a desired lagged inflation term always arises toghether with a two-period-ahead expectational expression. The two terms are directly linked by a novel structural parameter. We confront the relationships obtained by Sienknecht (2010a) against European data and compare their data description performance against the widespread extension of the Calvo setting with rule-of-thumb behavior

Adjustment cost-driven inflation inertia

This paper shows how endogeneous inflation inertia is generated by a simple modificaton of the quadratic adjustment cost structure faced by economic agents. We derive the pertinent inflation relationships based on purely nominal rigidities and show that they always involve additional expectation terms which are absent in a Calvo-type environment. However, the structural differences do not prevent dynamic adjustment paths and theoretical moments to be similar under both rigidity assumptions. An extensive application of nominal adjustment frictions leads to a full-scale macroeconomic framework able to replicate empirical responses to an interest rate shock

Robust policy choice under Calvo and Rotemberg pricing

This paper examines the robustness of welfare-based policy choices across the nonlinear Calvo and Rotemberg pricing assumptions. Comparisons between simple interest rate rules turn out to be robust and independent of the price dispersion inherent in the Calvo setting. This robustness is violated if there is a policy alternative that controls for price dispersion

Reassessing price adjustment costs in DSGE models

Indexation theories have become standard for inflation persistence in DSGE models (Smets and Wouters (2003, 2007)). However, these theories overlook an important stylized fact of U.S. business cycles: high fluctuations in the first difference of inflation. I find that this pattern can be captured by adjustment costs precisely from the first difference of inflation (Pesaran (1991) labels this difference as a "speed change"). I estimate four DSGE models differing in their rigidity assumption and find that a framework with inflation-based adjustment costs has the highest probability to fit U.S. data

Robust policy choice under Calvo and Rotemberg pricing

This paper examines the robustness of welfare-based policy choices across the nonlinear Calvo and Rotemberg pricing assumptions. Comparisons between simple interest rate rules turn out to be robust and independent of the price dispersion inherent in the Calvo setting. This robustness is violated if there is a policy alternative that controls for price dispersion