The standard derivation of a Phillips curve from a DSGE model requires that all variables are measured as deviations from their steady states. But in practice this is not done. The steady state for output is estimated by some statistical procedure, such as the HP filter, and the steady state for other variables, including inflation, is treated as a constant. This is inconsistent with the theory and raises econometric problems since inflation, for instance, is a very persistent series. We argue that the natural definition of the steady state is the long-horizon forecast and estimate these permanent components from a cointegrating VAR that takes account of global interactions. This estimate of the steady state will reflect any long-run theoretical relationships embodied in the cointegrating vectors. We then estimate Phillips Curves and other standard monetary transmission equations using deviations from the steady states on US data. This is both consistent with the theory and uses the relevant economic information about steady states.
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Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number
1366.
Find related papers by JEL classification: C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
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