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Supply, Demand and Monetary Policy Shocks in a Multi-Country New Keynesian Model

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Author Info

  • Stephane Dees
  • M. Hashem Pesaran
  • L. Vanessa Smith
  • Ron P. Smith

Abstract

This paper estimates and solves a multi-country version of the standard DSGE New Keynesian (NK) model. The country-specific models include a Phillips curve determining inflation, an IS curve determining output, a Taylor Rule determining interest rates, and a real effective exchange rate equation. The IS equation includes a real exchange rate variable and a country-specific foreign output variable to capture direct inter-country linkages. In accord with the theory all variables are measured as deviations from their steady states, which are estimated as long-horizon forecasts from a reduced-form cointegrating global vector autoregression. The resulting rational expectations model is then estimated for 33 countries on data for 1980Q1-2006Q4, by inequality constrained IV, using lagged and contemporaneous foreign variables as instruments, subject to the restrictions implied by the NK theory. The multi-country DSGE NK model is then solved to provide estimates of identified supply, demand and monetary policy shocks. Following the literature, we assume that the within country supply, demand and monetary policy shocks are orthogonal, though shocks of the same type (e.g. supply shocks in different countries) can be correlated. We discuss estimation of impulse response functions and variance decompositions in such large systems, and present estimates allowing for both direct channels of international transmission through regression coefficients and indirect channels through error spillover effects. Bootstrapped error bands are also provided for the cross country responses of a shock to the US monetary policy.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2010/wp-cesifo-2010-06/cesifo1_wp3081.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3081.

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Date of creation: 2010
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Handle: RePEc:ces:ceswps:_3081

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Keywords: global VAR (GVAR); New Keynesian DSGE models; supply shocks; demand shocks; monetary policy shocks;

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References

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  1. Pierre Perron & Tatsuma Wada, 2005. "Let’s Take a Break: Trends and Cycles in US Real GDP," Boston University - Department of Economics - Working Papers Series wp2009-006, Boston University - Department of Economics, revised Feb 2009.
  2. M. Hashem Pesaran & Til Schuermann & L. Vanessa Smith, 2008. "Forecasting Economic and Financial Variables with Global VARs," CESifo Working Paper Series 2263, CESifo Group Munich.
  3. Stephane Dees & Filippo di Mauro & M. Hashem Pesaran & L. Vanessa Smith, 2004. "Exploring the International Linkages of the Euro Area: A Global VAR Analysis," IEPR Working Papers 04.6, Institute of Economic Policy Research (IEPR).
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  6. Dees, S. & Holly, S. & Pesaran, M.H. & Smith, L.V., 2007. "Long Run Macroeconomic Relations in the Global Economy," Cambridge Working Papers in Economics 0703, Faculty of Economics, University of Cambridge.
  7. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
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  11. Peter N. Ireland, 2004. "Technology Shocks in the New Keynesian Model," NBER Working Papers 10309, National Bureau of Economic Research, Inc.
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  23. M. Hashem Pesaran & L. Vanessa Smith & Ron P. Smith, 2007. "What if the UK or Sweden had joined the euro in 1999? An empirical evaluation using a Global VAR," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 12(1), pages 55-87.
  24. Fan, Jianqing & Fan, Yingying & Lv, Jinchi, 2008. "High dimensional covariance matrix estimation using a factor model," Journal of Econometrics, Elsevier, vol. 147(1), pages 186-197, November.
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