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Structural estimation of the New-Keynesian model: A formal test of backward- and forward-looking behavior

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  • Jang, Tae-Seok
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    Abstract

    This paper attempts to uncover the empirical relationship between the price-setting/consumer behavior and the sources of persistence in inflation and output. First, a small-scale New-Keynesian model (NKM) is examined using the method of moment and maximum likelihood estimators with US data from 1960 to 2007. Then a formal test compares the fit of two competing specifications in the New-Keynesian Phillips Curve (NKPC) and the IS equation; i.e. forward- or backward-looking behavior. Accordingly, the inclusion of a lagged term in the NKPC and the IS equation improves the fit of the model while offsetting the influence of inherited and extrinsic persistence; it is shown that intrinsic persistence plays a major role in approximating the inflation and output dynamics for the Great Inflation period. However, the null hypothesis cannot be rejected at the 5% level for the Great Moderation period; i.e. the purely forward-looking behavior of the NKM and its hybrid variant are equivalent. Monte Carlo experiments illustrate the validity of the chosen moment conditions and the finite sample properties of classical estimation methods. Finally, the performance of the formal test is analyzed using the Akaike's and the Bayesian information criterion. --

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    Bibliographic Info

    Paper provided by Christian-Albrechts-University of Kiel, Department of Economics in its series Economics Working Papers with number 2012-07.

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    Date of creation: 2012
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    Handle: RePEc:zbw:cauewp:201207

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    Keywords: backward- and foward-looking behavior; formal test; information criterion; intrinsic persistence; maximum likelihood; method of moment; New-Keynesian;

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    Cited by:
    1. Sacht, Stephen & Jang, Tae-Seok, 2012. "Identification of Animal Spirits in a Bounded Rationality Model: An Application to the Euro Area," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century 62071, Verein für Socialpolitik / German Economic Association.

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