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Specifying and estimating New Keynesian models with instrument rules and optimal monetary policies

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  • Richard Dennis

Abstract

This paper estimates several popular sticky-price New Keynesian models in an effort to understand whether and under what circumstances these models can usefully describe observed outcomes. We estimate and compare specifications that contain different forms of habit formation, specifications that have either the gap or real marginal costs driving inflation, and specifications that use either optimal policymaking or a forward-looking Taylor-type rule to summarize monetary policy. Among other results, we find that the different forms of habit formation lead to very similar aggregate behavior, that optimal policymaking explains the data as well as a Taylor-type rule does, and that the data speak strongly against specifications that have real marginal costs as the driver in the Phillips curve.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2004-17.

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Date of creation: 2004
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Handle: RePEc:fip:fedfwp:2004-17

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Keywords: Monetary policy ; Keynesian economics ; Econometric models;

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  1. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  2. Jeffrey C. Fuhrer, 2000. "Optimal monetary policy in a model with habit formation," Working Papers, Federal Reserve Bank of Boston 00-5, Federal Reserve Bank of Boston.
  3. Jeffery D. Amato & Thomas Laubach, 2002. "Implications of habit formation for optimal monetary policy," BIS Working Papers 121, Bank for International Settlements.
  4. Sbordone, A.M., 1998. "Prices and Unit Labor Costs: a New Test of Price Stickiness," Papers, Stockholm - International Economic Studies 653, Stockholm - International Economic Studies.
  5. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(2), pages 339-57, April.
  6. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, October.
  7. McCallum, B.T. & Nelson, E., 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Papers, Stockholm - International Economic Studies 644, Stockholm - International Economic Studies.
  8. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, MIT Press, vol. 1(5), pages 1123-1175, 09.
  9. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 640, Board of Governors of the Federal Reserve System (U.S.).
  10. Michele Boldrin & Lawrence J. Christiano & Jonas D. M. Fisher, 2000. "Habit persistence, asset returns and the business cycle," Staff Report, Federal Reserve Bank of Minneapolis 280, Federal Reserve Bank of Minneapolis.
  11. Salemi, Michael K, 1995. "Revealed Preference of the Federal Reserve: Using Inverse-Control Theory to Interpret the Policy Equation of a Vector Autoregression," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 13(4), pages 419-33, October.
  12. Efrem Castelnuovo & Paolo Surico, 2004. "Model Uncertainty, Optimal Monetary Policy and the Preferences of the Fed," Scottish Journal of Political Economy, Scottish Economic Society, vol. 51(1), pages 105-126, 02.
  13. Favero, Carlo A & Rovelli, Riccardo, 2003. " Macroeconomic Stability and the Preferences of the Fed: A Formal Analysis, 1961-98," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 35(4), pages 545-56, August.
  14. repec:fth:harver:1435 is not listed on IDEAS
  15. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  16. Rochelle M. Edge & Thomas Laubach & John C. Williams, 2003. "The responses of wages and prices to technology shocks," Working Paper Series, Federal Reserve Bank of San Francisco 2003-21, Federal Reserve Bank of San Francisco.
  17. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
  18. Kim, Jinill, 2000. "Constructing and estimating a realistic optimizing model of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 45(2), pages 329-359, April.
  19. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  20. Duffy, John & McNelis, Paul D., 2001. "Approximating and simulating the stochastic growth model: Parameterized expectations, neural networks, and the genetic algorithm," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 25(9), pages 1273-1303, September.
  21. John B. Taylor, 1999. "Introduction to "Monetary Policy Rules"," NBER Chapters, in: Monetary Policy Rules, pages 1-14 National Bureau of Economic Research, Inc.
  22. Buiter, Willem H & Jewitt, Ian, 1981. "Staggered Wage Setting with Real Wage Relativities: Variations on a Theme of Taylor," The Manchester School of Economic & Social Studies, University of Manchester, University of Manchester, vol. 49(3), pages 211-28, September.
  23. Smets, Frank, 2003. "Maintaining price stability: how long is the medium term?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(6), pages 1293-1309, September.
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Cited by:
  1. Dennis, Richard & Leitemo, Kai & Söderström, Ulf, 2007. "Monetary Policy in a Small Open Economy with a Preference for Robustness," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6067, C.E.P.R. Discussion Papers.
  2. Richard Dennis, 2008. "Consumption-habits in a new Keynesian business cycle model," Working Paper Series, Federal Reserve Bank of San Francisco 2008-35, Federal Reserve Bank of San Francisco.
  3. Andrew T. Levin & Alexei Onatski & John Williams & Noah M. Williams, 2006. "Monetary Policy Under Uncertainty in Micro-Founded Macroeconometric Models," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 229-312 National Bureau of Economic Research, Inc.
  4. Männistö , Hanna-Leena, 2005. "Forecasting with a forward-looking DGE model: combining long-run views of financial markets with macro forecasting," Research Discussion Papers, Bank of Finland 21/2005, Bank of Finland.

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