Jang, TaeSeok (2012): Structural estimation of the NewKeynesian Model: a formal test of backward and forwardlooking expectations.

PDF
MPRA_paper_39669.pdf Download (427kB)  Preview 
Abstract
This paper attempts to uncover the empirical relationship between the pricesetting/consumer behavior and the sources of persistence in inflation and output. First, a smallscale NewKeynesian model (NKM) is examined using the method of moment and maximum likelihood estimators with US data from 1960 to 2007. Then a formal test compares the fit of two competing specifications in the NewKeynesian Phillips Curve (NKPC) and the IS equation; i.e., forward or backwardlooking expectations. Accordingly, the inclusion of a lagged term in the NKPC and the IS equation improves the fit of the model while offsetting the influence of inherited and extrinsic persistence; it is shown that intrinsic persistence plays a major role in approximating the inflation and output dynamics for the Great Inflation period. However, the null hypothesis cannot be rejected at the 5% level for the Great Moderation period; i.e. the NKM of purely forwardlooking behavior and its hybrid variant are equivalent. Monte Carlo experiments illustrate the validity of the chosen moment conditions and the finite sample properties of classical estimation methods. Finally, the empirical performance of model selection methods is investigated using the Akaike’s and the Bayesian information criterion.
Item Type:  MPRA Paper 

Original Title:  Structural estimation of the NewKeynesian Model: a formal test of backward and forwardlooking expectations 
Language:  English 
Keywords:  formal test; foward and backwardlooking expectations; information criterion; intrinsic persistence; maximum likelihood; method of moment; NewKeynesian model 
Subjects:  C  Mathematical and Quantitative Methods > C3  Multiple or Simultaneous Equation Models; Multiple Variables > C32  TimeSeries Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models E  Macroeconomics and Monetary Economics > E1  General Aggregative Models > E12  Keynes; Keynesian; PostKeynesian C  Mathematical and Quantitative Methods > C1  Econometric and Statistical Methods and Methodology: General > C12  Hypothesis Testing: General 
Item ID:  39669 
Depositing User:  TaeSeok Jang 
Date Deposited:  25. Jun 2012 23:55 
Last Modified:  12. Feb 2013 01:57 
References:  Altonji, J. and Segal, L. (1996): Smallsample bias in GMM estimation of covariance structures. Journal of Business and Economic Statistics, 14, 353–366. Amato, J.D. and Laubach, T. (2003): Ruleofthumb behaviour and monetary policy. European Economic Review, Vol. 47(5), pp. 791–831. Amato, J.D. and Laubach, T. (2004): Implications of habit formation for optimal monetary policy. Journal of Monetary Economics, Vol. 51, pp. 305–325. Anatolyev, S. and Gospodinov, N. (2011): Methods for Estimation and Inference in Modern Econometrics. New York: A Chapman and Hall Book. Andrews, D. (1991), Heteroskedasticity and autocorrelation consistent covariance matrix estimation. Econometrica, Vol. 59, pp. 817–858. Binder, M., and Pesaran, H. (1995): Multivariate Rational Expectations Models and Macroeconomic Modeling: a Review and Some Insights, In: Pesaran, M.H. and Wickens, M. (ed.), Handbook of Applied Econometrics. Oxford: Basil Blackwell, pp. 139–187. Caldara, D., FernandezVillaverde, J., RubioRamirez, J., and Yao, W. (2012): Computing DSGE models with recursive preferences and stochastic volatility. Review of Economic Dynamics, Vol. 15(2), pp. 188–206. Canova, F. and Sala, L. (2009): Back to square one: identification issues in DSGE models. Journal of Monetary Economics, Vol. 56(4), pp. 431–449. Carrillo, J.A., F´eve, P. and Matheron J. (2007): Monetary policy inertia or persistent shocks: a DSGE analysis. International Journal of Central Banking, Vol. 3(2), pp. 1–38. Castelnuovo, E. (2010): Trend inflation and macroeconomic volatilities in the Post WWII U.S. economy. North American Journal of Economics and Finance, Vol. 21, pp. 19–33. Christiano, L., Eichenbaum, M. and C. Evans (2005): Nominal rigidities and the dynamic effects of a shock to monetary policy. Journal of Political Economy Vol. 113(1), pp. 1–45. Clarida, R., and Gali, J. and Gertler, M. (2000): Monetary policy rules and macroeconomic stability: evidence and some theory. Quarterly Journal of Economics, Vol. 115, pp. 147–180. Coenen, G. (2005): Asymptotic confidence bands for the estimated autocovariance and autocorrelation functions of vector autoregressive models. Empirical Economics, Vol. 30(1), pp. 65–75. Cogley, T., and Sbordone, A. (2008): Trend inflation, indexation, and inflation persistence in the NewKeynesian Phillips curve. American Economic Review, Vol. 98(5), pp. 2101–2126. Cogley, T., Primiceri, G.E. and Sargent, T.J. (2010): Inflationgap persistence in the US. American Economic Journal: Macroeconomics, Vol. 2(1), pp. 4369. De Grauwe, P. (2010): Animal spirits and monetary policy. Economic Theory, Vol. 47, pp. 423–457. Dridi, R. and Guay, A. and Renault, E. (2007): Indirect inference and calibration of dynamic stochastic general equilibrium models. Journal of Econometrics, Vol. 136(2), pp. 397430. Franke, R., and Jang, T.S. and Sacht, S. (2011): Moment matching versus Bayesian estimation: backwardlooking behaviour in the NewKeynesian threeequations model. Economic Working paper 201110, University of Kiel. Fuhrer, J.C. (1997): The (un)importance of forwardLooking behavior in price specifications. Journal of Money, Credit and Banking, Vol. 29(3), pp. 338350. Fuhrer, J.C. (2000): Habit formation in consumption and its implications for monetary policy models. American Economic Review, Vol. 90(3), pp. 367390. Gali, J. and Gertler, M. (1999): Inflation dynamics: a structural econometric analysis. Journal of Monetary Economics, Vol. 44, pp. 195–222. Gill, P. and Murray, W. and Wright, M. (1981): Practical Optimization. Academic Press. Golden, R.M. (2000): Statistical tests for comparing possibly misspecified and nonnested models. Journal of Mathematical Psychology, Vol. 44, pp. 153–170. Golden, R.M. (2003): Discrepancy risk model selection test theory for comparing possibly misspecified or nonnested models. Psychometrika, Vol. 68(2), pp. 229–249. Gourieroux, C. and Monfort, A. (1995): Testing, encompassing and simulating dynamic econometric models. Econometric Theory, Vol. 11, pp. 195–228. Gregory, A.W and Smith, G.W. (1991): Calibration as testing: inference in simulated macroeconomic models. Journal of Business and Economic Statistics, Vol. 9(3), pp. 297–303. Hall, A.R., and Inoue, A., and Nason, J.M. and Rossi, B. (2011): Information criteria for impulse response function matching estimation of DSGE models, Journal of conometrics, forthcoming. Hnatkovska, V. and Marmer, V. and Tang, Y. (2012): Comparison of misspecified calibrated models: the minimum distance approach. Journal of Econometrics, Forthcoming. Hnatkovska, V. and Marmer, V. and Tang, Y. (2011): Supplement to "Comparison of misspecified calibrated models". Working paper, University of Britisch Columbia. Ireland, P.N. (2004): A method for taking models to the data. Journal of Economic Dynamics and Control, Vol. 28, pp. 1205–1226. Jang, T.S. and Sacht, S (2012): Identification of animal spirits in a bounded rationality model: an application to the Euro area. MPRA Paper No. 37399, University Library of Munich, Germany. Lahiri, S.N. (2003): Resampling Methods for Dependent Data. Berlin: Springer. Lee, B.S. and Ingram, B.F. (1991): Simulation estimation of timeseries models. Journal of Econometrics, Vol. 47, pp. 197205. Linde, J. (2005): Estimating NewKeynesian Phillips curves: a full information maximum likelihood approach. Journal of Monetary Economics, Vol. 52, pp. 1135–49. Linhart, H. and Zucchini, W. (1986): Model Selection. New York: John Wiley & Sons Inc. Marmer, V. and Otsu, T. (2012): Optimal comparison of misspecified moment restriction models under a chosen measure of fit. Journal of Econometrics, forthcoming. Nason, J.M. and Smith, G.W. (2008): Identifying the New Keynesian Phillips curve. Journal of Applied Econometrics, Vol. 23, pp. 525–551. Newey, W. and West, K. (1987), A simple positive semidefinite, heteroskedasticty and autocorrelation consistent covariance matrix. Econometrica, Vol. 55, pp. 703–708. Newey, W. and West, K. (1994): Automatic lag selection in covariance matrix estimation. Review of Economic Studies, Vol. 61(4), pp. 631–53. Rabanala, P. and RubioRamirezb, J.F. (2005): Comparing New Keynesian models of the business cycle: a Bayesian approach. Journal of Monetary Economics, Vol. 52(6), pp. 1151–1166. Rivers, D. and Vuong, Q. (2002): Model selection tests for nonlinear dynamic models. Econometrics Journal, Vol. 5, pp. 1–39. Rotemberg, J. and Woodford, M. (1997): An optimizationbased econometric framework for the evaluation of monetary policy. NBER Macroeconomics Annual, Cambridge, MA: MIT Press. Rudd, J. and Whelan, K. (2005): New tests of the NewKeynsian Phillips curve. Journal of Monetary Economics, Vol. 52, pp. 1167–1181. Rudd, J. and Whelan, K. (2006): Can rational expectations stickyprice models explain inflation dynamics. American Economic Review, Vol. 96(1), pp. 303–320. Smets, F. and Wouters, R. (2003): An estimated stochastic dynamic general equilibrium model of the Euro area. Journal of European Economic Association, Vol. 1(5), pp. 1123–1175. Smets, F. and Wouters, R. (2005): Comparing shocks and frictions in US and Euro area business cycles: a Bayesian DSGE approach. Journal of Applied Econometrics, Vol. 20(2), pp. 161–183. Smets, F. and Wouters, R. (2007): Shocks and frictions in US business cycles: a Bayesian DSGE approach. American Economic Review, Vol. 97(3), pp. 586–606. Vuong, Q. (1989): Likelihood ratio tests for model selection and nonnested hypotheses. Econometrica, Vol. 57(2), pp. 307–333. 
URI:  http://mpra.ub.unimuenchen.de/id/eprint/39669 