Advanced Search
MyIDEAS: Login

Maximum Likelihood Estimation of Dynamic Stochastic Theories with an Application to New Keynesian Pricing

Contents:

Author Info

  • André Kurmann

Abstract

This paper proposes a novel Maximum Likelihood (ML) strategy to estimate Euler equations implied by dynamic stochastic theories. The strategy exploits rational expectations cross-equation restrictions, but circumvents the problem of multiple solutions that arises in Sargent's (1979) original work by imposing the restrictions on the forcing variable rather than the endogenous variable of the Euler equation. The paper then contrasts the proposed strategy to an alternative, widely employed method that avoids the multiplicity problem by constraining the ML estimates to yield a unique stable solution. I argue that imposing such a uniqueness condition makes little economic sense and can lead to severe misspecification. To illustrate this point, I estimate Gali and Gertler's (1999) hybrid New Keynesian Phillips Curve using labor income share as the measure of real marginal cost. My ML estimates indicate that forward-looking behavior is predominant and that the model provides a good approximation of U.S. inflation dynamics. By contrast, if the same estimates are constrained to yield a unique stable solution, forward-looking behavior becomes much less important and the model as a whole is rejected.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.cirpee.org/fileadmin/documents/Cahiers_2004/CIRPEE04-21.pdf
Download Restriction: no

Bibliographic Info

Paper provided by CIRPEE in its series Cahiers de recherche with number 0421.

as in new window
Length:
Date of creation: 2004
Date of revision:
Handle: RePEc:lvl:lacicr:0421

Contact details of provider:
Postal: CP 8888, succursale Centre-Ville, Montréal, QC H3C 3P8
Phone: (514) 987-8161
Web page: http://www.cirpee.org/
More information through EDIRC

Related research

Keywords: Maximum Likelihood; Rational Expectations; New Keynesian Phillips Curve; Inflation; Real Marginal Cost;

Other versions of this item:

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, vol. 112(5), pages 947-985, October.
  2. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  3. Jordi Gali & Mark Gertler, 2000. "Inflation Dynamics: A Structural Econometric Analysis," NBER Working Papers 7551, National Bureau of Economic Research, Inc.
  4. King, Robert G & Watson, Mark W, 1998. "The Solution of Singular Linear Difference Systems under Rational Expectations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 1015-26, November.
  5. Sbordone, Argia M., 2005. "Do expected future marginal costs drive inflation dynamics?," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1183-1197, September.
  6. Eric JONDEAU & Herve LE BIHAN, 2003. "ML vs GMM Estimates of Hybrid Macroeconomic Models (With an Application to the "New Phillips Curve")," Econometrics 0303006, EconWPA.
  7. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Finance and Economics Discussion Series 93-17, Board of Governors of the Federal Reserve System (U.S.).
  8. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  9. Peter Tinsley & Sharon Kozicki, 2003. "Alternative Sources of the Lag Dynamics of Inflation," Computing in Economics and Finance 2003 92, Society for Computational Economics.
  10. Thomas J. Sargent, 1978. "A note on maximum likelihood estimation of the rational expectations model of the term structure," Staff Report 26, Federal Reserve Bank of Minneapolis.
  11. 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.
  12. Bils, Mark, 1987. "The Cyclical Behavior of Marginal Cost and Price," American Economic Review, American Economic Association, vol. 77(5), pages 838-55, December.
  13. Fuhrer, Jeffrey C. & Moore, George R. & Schuh, Scott D., 1995. "Estimating the linear-quadratic inventory model Maximum likelihood versus generalized method of moments," Journal of Monetary Economics, Elsevier, vol. 35(1), pages 115-157, February.
  14. James M. Nason & Gregor W. Smith, 2005. "Identifying the New Keynesian Phillips curve," Working Paper 2005-01, Federal Reserve Bank of Atlanta.
  15. Hansen, Lars Peter & Sargent, Thomas J., 1980. "Formulating and estimating dynamic linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 7-46, May.
  16. Fuhrer, Jeffrey C. & Rudebusch, Glenn D., 2004. "Estimating the Euler equation for output," Journal of Monetary Economics, Elsevier, vol. 51(6), pages 1133-1153, September.
  17. Lubik, Thomas A. & Schorfheide, Frank, 2003. "Computing sunspot equilibria in linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 273-285, November.
  18. John M. Roberts, 1994. "Is inflation sticky?," Working Paper Series / Economic Activity Section 152, Board of Governors of the Federal Reserve System (U.S.).
  19. James H. Stock & Motohiro Yogo, 2002. "Testing for Weak Instruments in Linear IV Regression," NBER Technical Working Papers 0284, National Bureau of Economic Research, Inc.
  20. Martin Eichenbaum & Jonas D.M. Fisher, 2003. "Evaluating the Calvo model of sticky prices," Working Paper Series WP-03-23, Federal Reserve Bank of Chicago.
  21. Eric Jondeau & Hervé Le Bihan, 2001. "Testing for a Forward-Looking Phillips Curve. Additional Evidence from European and US data," Macroeconomics 0111005, EconWPA.
  22. Stock, James H & Wright, Jonathan H & Yogo, Motohiro, 2002. "A Survey of Weak Instruments and Weak Identification in Generalized Method of Moments," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(4), pages 518-29, October.
  23. John M. Roberts, 2005. "How Well Does the New Keynesian Sticky-Price Model Fit the Data?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 0(1), pages 10.
  24. Alexander L. Wolman, 2000. "The frequency and costs of individual price adjustments," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-22.
  25. Robrt G. King & André Kurmann, 2002. "Expectations and the term structure of interest rates : evidence and implications," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 49-95.
  26. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
  27. William L. Goffe, 1996. "SIMANN: A Global Optimization Algorithm using Simulated Annealing," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 1(3), pages al1.
  28. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  29. Ma, Adrian, 2002. "GMM estimation of the new Phillips curve," Economics Letters, Elsevier, vol. 76(3), pages 411-417, August.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Bakhshi, Hasan & Khan, Hashmat & Rudolf, Barbara, 2006. "The Phillips Curve Under State-Dependent Pricing," CEPR Discussion Papers 5945, C.E.P.R. Discussion Papers.
  2. Kevin D. Sheedy, 2007. "Intrinsic Inflation Persistence," CEP Discussion Papers dp0837, Centre for Economic Performance, LSE.
  3. Jordi Galí & Mark Gertler & David López-Salido, 2005. "Robustness of the Estimates of the Hybrid New Keynesian Phillips Curve," Banco de España Working Papers 0520, Banco de España.
  4. Jondeau, E. & Le Bihan, H., 2003. "ML vs GMM Estimates of Hybrid Macroeconomic Models (With an Application to the New Phillips Curve)," Working papers 103, Banque de France.
  5. André Kurmann, 2003. "Quantifying the Uncertainty about the Fit of a New Keynesian Pricing Model: Extended Version," Cahiers de recherche 0344, CIRPEE.
  6. Fanelli, Luca, 2005. "Testing the New Keynesian Phillips curve through Vector Autoregressive models: Results from the Euro area," MPRA Paper 1617, University Library of Munich, Germany, revised Jan 2007.
  7. Rudolf, B. & Bakhshi, H., 2005. "The Phillips Curve Under State-Dependent Pricing," Computing in Economics and Finance 2005 68, Society for Computational Economics.
  8. Fanelli, Luca, 2008. "Evaluating the New Keynesian Phillips Curve under VAR-Based Learning," Economics Discussion Papers 2008-15, Kiel Institute for the World Economy.
  9. Linde, Jesper, 2005. "Estimating New-Keynesian Phillips curves: A full information maximum likelihood approach," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1135-1149, September.
  10. Fanelli, Luca, 2008. "Evaluating New Keynesian Phillips Curve under VAR-Based Learning," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 2(33), pages 1-24.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:lvl:lacicr:0421

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Johanne Perron).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.