Structural estimation of the New-Keynesian Model: a formal test of backward- and forward-looking expectations

Jang, Tae-Seok (2012): Structural estimation of the New-Keynesian Model: a formal test of backward- and forward-looking expectations.

Abstract

This paper analyzes the empirical relationship between the price-setting/consumer behavior and the sources of persistence in inflation and output. First, a small-scale New-Keynesian 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 New-Keynesian Phillips Curve (NKPC) and the IS equation; i.e. backward- and forward-looking behavior. 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 with purely forward-looking behavior and its hybrid variant are equivalent. Monte Carlo experiments are used to investigate the validity of moment conditions and the finite sample properties of the classical estimation methods. Finally, the empirical performance of the formal test is discussed along the lines of the Akaike’s and the Bayesian information criterion.

• Item Type: MPRA Paper
• Language: English
• Keywords: backward- and foward-looking behavior; formal test; information criterion; intrinsic persistence; maximum likelihood; method of moment; New-Keynesian
• 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 ; Diffusion Processes ; State Space Models; E - Macroeconomics and Monetary Economics > E1 - General Aggregative Models > E12 - Keynes ; Keynesian ; Post-Keynesian; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C12 - Hypothesis Testing: General

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