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Inspecting the noisy mechanism: the stochastic growth model with partial information

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  • Liam Graham

    (University College)

  • Stephen Wright

    (Birkbeck College)

Abstract

We derive a framework (and provide a software toolkit) which allows the dynamic general equilibrium modeller to specify what variables are in households' information sets, and the degree to which these variables are measured with error. We apply this framework to a canonical real business cycle model and show that which variables are observable has a significant effect, both qualitatively and quantitatively, on the dynamics of the model. Specifically, we find (i) The standard decentralised equilibrium, with households only observing returns and not aggregate quantities, is not stable to arbitrarily small measurement error (ii) A stable solution does exist, but it is dramatically different from the full-information case (iii) Having aggregate output data, even if relatively noisy, brings the economy much closer to the full-information solution

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 207.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:207

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Keywords: DGE; Partial information; Measurement error;

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  1. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 11-44, January.
  2. Athanasios Orphanides & Simon van Norden, 1999. "The reliability of output gap estimates in real time," Finance and Economics Discussion Series 1999-38, Board of Governors of the Federal Reserve System (U.S.).
  3. John Laitner & Dmitriy Stolyarov, 2003. "Technological Change and the Stock Market," American Economic Review, American Economic Association, vol. 93(4), pages 1240-1267, September.
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  5. John Y. Campbell, 1992. "Inspecting the Mechanism: An Analytical Approach to the Stochastic Growth Model," NBER Working Papers 4188, National Bureau of Economic Research, Inc.
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  8. Robert E. Hall, 1999. "The Stock Market and Capital Accumulation," NBER Working Papers 7180, National Bureau of Economic Research, Inc.
  9. Pearlman, Joseph G., 1992. "Reputational and nonreputational policies under partial information," Journal of Economic Dynamics and Control, Elsevier, vol. 16(2), pages 339-357, April.
  10. Aoki, Kosuke, 2002. "Optimal Commitment Policy Under Noisy Information," CEPR Discussion Papers 3370, C.E.P.R. Discussion Papers.
  11. Orphanides, Athanasios, 2003. "Monetary policy evaluation with noisy information," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 605-631, April.
  12. Quah, D., 1989. "Permanent And Transitory Movements In Labor Income: An Explanation For "Excess Smoothness" In Consumption," Working papers 535, Massachusetts Institute of Technology (MIT), Department of Economics.
  13. Athanasios Orphanides & Richard D. Porter & David Reifschneider & Robert Tetlow & Frederico Finan, 1999. "Errors in the measurement of the output gap and the design of monetary policy," Finance and Economics Discussion Series 1999-45, Board of Governors of the Federal Reserve System (U.S.).
  14. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  15. Pearlman, Joseph, 1986. "Diverse information and rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 10(1-2), pages 333-338, June.
  16. Svensson, Lars & Woodford, Michael, 2000. "Indicator Variables for Optimal Policy," Seminar Papers 688, Stockholm University, Institute for International Economic Studies.
  17. Prescott, Edward C & Mehra, Rajnish, 1980. "Recursive Competitive Equilibrium: The Case of Homogeneous Households," Econometrica, Econometric Society, vol. 48(6), pages 1365-79, September.
  18. Lars E. O. Svensson & Michael Woodford, 2003. "Optimal Policy with Partial Information in a Forward-Looking Model: Certainty-Equivalence Redux," NBER Working Papers 9430, National Bureau of Economic Research, Inc.
  19. Aoki, Kosuke, 2003. "On the optimal monetary policy response to noisy indicators," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 501-523, April.
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