url
17
May
2014

SIMPLE MONETARY POLICY RULES UNDER MODEL UNCERTAINTY: Comparison of Basic Model Properties 4

The FRB model explicitly models potential output as a function of the labor force, crude energy use, and a composite capital stock, using a three-factor Cobb-Douglas production technology. The equilibrium output price is a markup over a weighted average of the productivity-adjusted wage rate and the domestic energy price. The specification of wage and price dynamics follows the generalized adjustment cost framework used in the FRB IS block. Wage inflation depends on its own (three) lagged values, expected future growth in prices and productivity, and a weighted average of expected future unemployment rates; price inflation depends on its own (two) lagged values, expected future changes in equilibrium prices, and expected future unemployment rates. In addition, both wages and prices error-correct to their respective equilibrium levels. As in the other models, a vertical long-run Phillips curve is imposed in estimation.

Unlike the other three models, the FRB model contains a detailed accounting of various categories of income, taxes, and stocks, an explicit treatment of labor markets, and endogenous determination of potential output. Long-run equilibrium in the FRB model is of the stock-flow type; the income tax rate and real exchange rate risk premium adjust over time to bring government and foreign debt-to-GDP ratios back to specified (constant) levels. read only

Foreign Sector. Neither FM nor MSR explicitly include foreign variables; in contrast, both TAYMCM and the full FRB staff model include detailed treatments of foreign variables. TAYMCM features estimated equations for demand components and wages and prices for the other G-7 countries at about the level of aggregation of the U.S. sector. The full FRB staff model includes a total of 12 sectors (countries or regions) which encompass the entire global economy. Because of the size of the model, the cost of solving and computing the moments of the full FRB model is prohibitive. Preliminary investigations using TAYMCM suggest that the characteristics of optimal U.S. monetary policies are not greatly affected by the precise specification of the foreign sector. Based on these results and a need to economize on computational costs, we replaced the full set of equations describing foreign countries in the FRB staff model with two simple reduced form equations for foreign output and prices. For the remainder of the paper, we refer to this simplified version of the model as the FRB model.

The FRB model explicitly models potential output as a function of the labor force, crude energy use, and a composite capital stock, using a three-factor Cobb-Douglas production technology. The equilibrium output price is a markup over a weighted average of the productivity-adjusted wage rate and the domestic energy price. The specification of wage and price dynamics follows the generalized adjustment cost framework used in the FRB IS block. Wage inflation depends on its own (three) lagged values, expected future growth in prices and productivity, and a weighted average of expected future unemployment rates; price inflation depends on its own (two) lagged values, expected future changes in equilibrium prices, and expected future unemployment rates. In addition, both wages and prices error-correct

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Kevin J. Brandon

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