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Monetary policy in an estimated stochastic dynamic general equilibrium model of the Euro area

  • Frank Smets
  • Raf Wouters

This paper, first, develops and estimates a stochastic dynamic general equilibrium (SDGE) model with sticky prices and wages for the euro area. The model incorporates various other features such as habit formation, costs of adjustment in capital accumulation and variable capacity utilisation and is estimated using seven key macro-economic variables: GDP, consumption, investment, prices, real wages, employment and the nominal interest rate. The introduction of eight orthogonal structural shocks (including productivity, labour supply, preference, cost-push and monetary policy shocks) allows for an empirical investigation of the effects of such shocks and of their contribution to business cycle fluctuations in the euro area. For example, it is found that productivity shocks account for only 10 percent of the long run variance in output. Using the estimated model, the paper then analyses the output (real interest rate) gap, defined as the difference between the actual and the flexible-price level of output (real interest rate). Finally, the estimated model is also used to analyse optimal monetary policy.

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Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2002)
Issue (Month): Mar ()
Pages:

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Handle: RePEc:fip:fedfpr:y:2002:i:mar:x:2
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  10. Jeffery D. Amato & Thomas Laubach, 1999. "Monetary policy in an estimated optimization-based model with sticky prices and wages," Research Working Paper 99-09, Federal Reserve Bank of Kansas City.
  11. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
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  40. Ireland, Peter N., 2001. "Technology shocks and the business cycle: On empirical investigation," Journal of Economic Dynamics and Control, Elsevier, vol. 25(5), pages 703-719, May.
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