Fanelli, Luca (2007): Evaluating the New Keynesian Phillips Curve under VAR-based learning.
Download (483kB) | Preview
This paper proposes the evaluation of the New Keynesian Phillips Curve (NKPC) under a new learning mechanism where VAR learning dynamics is combined with the idea of testing the validity of the forward-looking model of inflation dynamics. The key assumption is that agents’ perceived law of motion is a VAR whose parameters are updated by recursive least squares. Differently from standard adaptive learning methods, agents test sequentially the cross-equation restrictions that the NKPC imposes on the VAR as the information set increases. When the restrictions are not rejected agents learn under the restricted system and exploit the cross-equation restrictions to forecast inflation. It is thus possible to check how much and in which periods agents’ beliefs are consistent with the restrictions of the theory. The empirical analysis on quarterly data on the euro area shows that the NKPC with negligible backward-looking parameter is not rejected when the model is evaluated over the period 1984-2005 under the proposed learning mechanism. The result, however, is not fully robust to specifications based on non stationary variables and points out that learning may represent a remarkable source of euro area inflation persistence but not its only determinant.
|Item Type:||MPRA Paper|
|Institution:||Department of Statistics, University of Bologna|
|Original Title:||Evaluating the New Keynesian Phillips Curve under VAR-based learning|
|Keywords:||Adaptive learning; Cross-equation restrictions; Forward-looking model of inflation dynamics; Perceived Law of Motion; Recursive Least Squares; VAR|
|Subjects:||C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models; Multiple Variables > C32 - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models
C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C52 - Model Evaluation, Validation, and Selection
E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E10 - General
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search; Learning; Information and Knowledge; Communication; Belief
|Depositing User:||Luca Fanelli|
|Date Deposited:||31. Jan 2007|
|Last Modified:||12. Feb 2013 18:40|
Baillie, R. T. (1989), Econometric tests of rationality and market efficiency, Econometric Reviews 8, 151-186. Batini, N. (2006), Euro are inflation persistence, Empirical Economic 31, 977 - 1002. Benigno, P., López-Salido, J.D. (2006), Inflation persistence and optimal monetary policy in the euro area, Journal of Money Credit and Banking 38, 587-614. Branch, W.A. (2004), The theory of rationally heterogeneous expectations: evidence from survey data on inflation expectations, Economic Journal 114, 592-621. Branch, W.A., Evans, G.W. (2006), A simple recursive forecasting model, Economic Letters 91, 158-166. Brayton, F., Eileen, M., Reifschneider, Tinsley, P., Williams, J. (1997), The role of expectations in the FRB/US macroeconomic model, Federal Reserve Bulletin 83 (April), 227-245. Bullard, J., Mitra, K. (2002), Learning about monetary policy rules, Journal of Monetary Economics 49, 1105-1129. Campbell, J. Y., Shiller, R. J. (1987), Cointegration and tests of present value models, Journal of Political Economy 95, 1062—1088. 26 Carceles-Poveda, E., Giannitsarou (2006), Adaptive learning in practise, Journal of Economic Dynamics and Control, forthcoming. Del Negro, M., Schorfheide, F. (2006), Monetary policy analysis with potentially misspecified models, paper presented at the 17th EC2 Meeting, “The Econometrics of Monetary Policy and Financial Decision-Making”, December 15-16, 2006, Rotterdam. Doornik, J. A, Hendry, D. F. (2001), Modelling Dynamic Systems Using PcGive, Timberlake Consultants Press, London. Dufour, J.-M, Jouini, T. (2006), Finite-sample simulation-based inference in VAR models with application to Granger causality testing, Journal of Econometrics 135, 229-254. Evans, G. W. and Honkapohja, S. (1999), Learning dynamics, in Handbook of Macroeconomics 1A, Chap. 7. Evans, G. W., Honkapohja, S. (2001), Learning and expectations in macroeconomics, Princeton University Press. Evans, G. W., Honkapohja, S. (2003a), Adaptive learning and monetary policy design, Journal of Money, Credit and Banking 35, 1045-1072. Evans, G. W., Honkapohja, S. (2003b), Expectations and the stability problem for optimal monetary policies, Review of Economic Studies 70, 807-824. Fagan, G., Henry, G. and Mestre, R. (2001), An area-wide model (awm) for the Euro area, European Central Bank, Working Paper No. 42. Fanelli, L. (2006a), Dynamic adjustment cost models with forward-looking behavior, Econometrics Journal 9, 23-47. Fanelli, L. (2006b), Multi-equational linear quadratic adjustment cost models with rational expectations and cointegration, Journal of Economic Dynamics and Control 30, 445-456. Fanelli, L. (2006c), Testing the New Keynesian Phillips Curve through Vector Autoregressive models: Results from the Euro area, Working Paper, University of Bologna. Fuhrer, J. (1997), The (un)importance of forward-looking behavior in price specifications, Journal of Money Credit and Banking 29, 338-350. Fuhrer, J., Moore, G. (1995), Inflation persistence, Quarterly Journal of Economics 110, 127- 159. Galí, J., Gertler, M. (1999), Inflation dynamics: a structural econometric analysis, Journal of Monetary Economics 44, 195-222. Galí, J., Gertler M. and Lopez-Salido, J.D. (2001), European inflation dynamics, European Economic Review 45, 1237-1270. Goffe,W. L., Ferrier, G. D. and Rogers, J. (1994), Global optimization of statistical functions with simulated annealing, Journal of Econometrics 60, 65-99. Hansen, L.P., Sargent, T.J. (1980), Formulating and estimating dynamic linear rational expectations models, Journal of Economic Dynamics and Control 2, 7-46. Hansen, L.P., Sargent, T.J. (1981), Linear rational expectations models for dynamically interrelated variables, in: Lucas R.E.Jr., Sargent, T.J. (dds.), Rational Expectations and Econometric Practise. University of Minnesota Press, Minneapolis, pp. 127-156. Inoue, A., Rossi, B. (2005), Recursive predictability tests for real-time data, Journal of Business and Economic Statistics 23, 336-345. Ireland, P. (2004), A Method for taking models to the data, Journal of Economic Dynamics and Control 28, 1205-1226. Johansen, S. (1996), Likelihood-based inference in cointegrated Vector Auto-Regressive models, Oxford University Press, Second revised version, Oxford. Johansen, S. (2006), Confronting the economic model with the data, in Colander, D. (ed): Post Walrasian Macroeconomics, Cambridge University Press, Cambridge, pp. 287-300. Johansen, S., Swensen, A. R. (1999), Testing exact rational expectations in cointegrated vector autoregressive models, Journal of Econometrics 93, 73-91. Kozicki, S., Tinsley, P. A. (1999), Vector rational error correction, Journal of Economic Dynamics and Control 23, 1299-1327. Kurmann, A. (2006), Maximum likelihood estimation of dynamic stochastic theories with an application to New Keynesian pricing, Journal of Economic Dynamics and Control, forthcoming. Lindé, J. (2005), Estimating New Keynesian Phillips curves: A full information maximum likelihood approach, Journal of Monetary Economics 52, 1135-1149. Lubik, T., Schorfheide, F. (2004), Testing for indeterminacy: an application to U.S. monetary policy, American Economic Review 2004, 94, 190-217. Marcet, A., Sargent, T.J. (1992), The convergence of Vector Autoregressions to rational expectations equilibria, in A. Vercelli and N. Dimitri (eds.), Macroeconomics: A Survey Of Reserach Strategies, Oxford, Oxford University Press 139-164. Mavroeidis, S. (2004), Weak identification of forward-looking models in monetary economics, Oxford Bulletin of Economics and Statistics 66 (Supplement), 609-635. Mavroeidis, S. (2005), Identification issues in forward-looking models estimated by GMM, with an application to the Phillips curve, Journal of Money Credit and Banking 37, 421 448. Mavroeidis, S. (2006), Testing the New Keynesian Phillips Curve without assuming identification, paper presented at the 17th EC2 Meeting, “The Econometrics of Monetary Policy and Financial Decision-Making”, December 15-16, 2006, Rotterdam. McCallum, B. T. (1983), On non-uniqueness in rational expectations models: an attempt at perspective, Journal of Monetary Economics 11, 139-168. McCallum, B. T. (2003), The unique minimum state variable RE solutuion is E-stable in all well formulated models, NBER, Working Paper No. 9960. Milani, F. (2005a), Adaptive learning and inflation persistence, Working Paper, University of California, Irvine. Milani, F. (2005b), Expectaions, learning and macroeconomic persistence, Working Paper, University of California, Irvine. Muth, J.F. (1961), Rational expectations and the theory of price movements, Econometrica 29, 315-335. Nason, J. M., Smith, G. W. (2005), Identifying the New Keynesian Phillips curve, Research Department, Federal Reserve Bank of Atlanta. Orphanides, A., Williams, J.C. (2005), The decline of activist stabilization policy: Natural rate mispercpections, learning, and expectations, Journal of Economic Dynamics and Control 29, 1927-1950. O’Relly, G., Whelan, K. (2005), Has euro-area inflation persistence changed over time ?, Review of Economics and Statistics 87, 709-720. Pesaran, H. M. (1987), The limits to rational expectations, Basil Blackwell, Oxford. Primicieri, G. (2006), Why inflation rose and fell: policy-makers’ beliefs and U.S. postwar stabilization policy, Quarterly Journal of Economics, March 867-901. Roberts, J. M. (1995), New Keynesian economics and the Phillips curve, Journal of Money, Credit, and Banking 27 (4), 975-984. Roberts, J. M. (1997), Is inflation sticky?, Journal of Monetary Economics 39, 173-196. Ruud, J., Whelan, K. (2005a), Does labor’s share drive inflation ?, Journal of Money Credit and Banking 37, 297-312. Ruud, J., Whelan, K. (2005b), New tests of the New Keynesian Phillips curve, Journal of Monetary Economics 52, 1167-1181. Ruud, J., Whelan, K. (2006), Can rational expectations sticky-price models explain inflation dynamics?, American Economic Review 96, 303-320. Sargent, T.J. (1979). A note on the maximum likelihood estimation of the rational expectations model of the term structure, Journal of Monetary Economics 5, 133-143. Sargent, T.J. (1987), Macroeconomic theory (second edition), San Diego, Academic Press. Sargent, T.J. (1999), The conquest of American inflation, Princeton University Press, Princeton. Sbordone, A.M. (2002), Prices and unit labor costs: a new test of price strickiness, Journal of Monetary Economics 49, 265-292. Sbordone, A.M. (2005), Do expected future marginal costs drive inflation dynamics ?, Journal of Monetary Economics 52, 1183-1197. Smets, F., Wouters, R. (2003), An estimated dynamic stochastic general equilibrium model of the Euro area, Journal of the European Economic Association 1(5), 1123-1175. Woodford, M. (2003), Interest and prices: Foundations of a theory of monetary policy, Princeton Universiyt Press, Princeton.