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11
May
2014

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

Table 1 outlines the basic features of the four models with respect to the level of aggregation of the IS, price, labor, and external sector blocks, specification of price dynamics, the characteristics of the forward-looking terms in the IS block (bond duration and discounting for permanent income), and the estimation period. The behavioral equations of FM were estimated using FIML and a combination of OLS, 2SLS, and GMM were used for the other three models.

FM MSR FRB TAYMCM
IS Components 1 5 17 10
Price Variables 2 2 7 5
Labor Variables 0 0 4 0
Asset Prices 1 2 7 2
Foreign Variables 0 0 2 2 95
Wage and Price Staggered Staggered Generalized Staggered
Dynamics real wage real wage adjustment nominal wage
contracts contracts costs contracts
Duration of Bond 30 years 2 years 5 years3 2 years
Permanent Income N/A 10% 7% 10%
Discount Rate per quarter per quarter per quarter
Estimation Period 1982-941 1980-96 1966-95 1971-86

Aggregate Demand. FM represents aggregate spending by a single reduced-form equation corresponding to an IS curve. The current output gap depends on its lagged values over the past two quarters and the lagged value of the long-term real interest rate, which is defined as a weighted average of ex ante short-term real interest rates with duration equivalent to a 30 year coupon bond, with estimated coefficients taken from Fuhrer (1997a). FM does not explicitly include trade variables or exchange rates; instead, net exports (and the relationship between real interest and real exchange rates) are implicitly incorporated in the IS curve equation. no checking account payday loans

The MSR model disaggregates real spending into five components: private consumption, fixed investment, inventory investment, net exports, and government purchases. The IS components exhibit partial adjustment to their respective equilibrium levels, measured as shares of potential GDP. Equilibrium consumption is a function of permanent income (discounted 10% per quarter) and the real (two-year) bond rate, equilibrium fixed investment is a function of output growth and the real bond rate, and equilibrium inventory investment depends only on output growth. Equilibrium government purchases are a constant share of GDP. Net exports are assumed to be fixed in the simulations reported here.

Table 1 outlines the basic features of the four models with respect to the level of aggregation of the IS, price, labor, and external sector blocks, specification of price dynamics, the characteristics of the forward-looking terms in the IS block (bond duration and discounting for permanent income), and the estimation period. The behavioral equations of FM were estimated using FIML and a combination of OLS, 2SLS, and GMM were used for the other three models. FM MSR FRB TAYMCM IS Components 1 5 17 10 Price Variables 2 2 7 5 Labor Variables 0 0 4 0 Asset Prices 1 2 7 2 Foreign Variables 0 0 2 2 95 Wage and Price Staggered Staggered Generalized Staggered Dynamics real wage

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Kevin J. Brandon

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