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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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  1. 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.
  2. 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.
  3. Peersman, Gert & Smets, Frank, 2002. "The industry effects of monetary policy in the euro area," Working Paper Series 0165, European Central Bank.
  4. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  5. Casares, Miguel, 2001. "Business cycle and monetary policy analysis in a structural sticky-price model of the euro area," Working Paper Series 0049, European Central Bank.
  6. Edward Nelson, 2000. "Direct effects of base money on aggregate demand: theory and evidence," Bank of England working papers 122, Bank of England.
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  8. Lars E.O. Svensson & Michael Woodford, 2000. "Indicator Variables for Optimal Policy," NBER Working Papers 7953, National Bureau of Economic Research, Inc.
  9. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 1-90, Wharton School Rodney L. White Center for Financial Research.
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  11. Amato, Jeffery D. & Laubach, Thomas, 2003. "Rule-of-thumb behaviour and monetary policy," European Economic Review, Elsevier, vol. 47(5), pages 791-831, October.
  12. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: a Quantitative Investigation," Cahiers de recherche 9614, Universite de Montreal, Departement de sciences economiques.
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  14. Soderlind, Paul, 1999. "Solution and estimation of RE macromodels with optimal policy," European Economic Review, Elsevier, vol. 43(4-6), pages 813-823, April.
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  18. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  19. Jordi Gali, 2002. "New Perspectives on Monetary Policy, Inflation, and the Business Cycle," NBER Working Papers 8767, National Bureau of Economic Research, Inc.
  20. Olivier Jean Blanchard & Danny Quah, 1988. "The Dynamic Effects of Aggregate Demand and Supply Disturbance," Working papers 497, Massachusetts Institute of Technology (MIT), Department of Economics.
  21. Peter Ireland, 1999. "A Method for Taking Models to the Data," Computing in Economics and Finance 1999 1233, Society for Computational Economics.
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  23. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  24. Michael Ehrmann and Frank Smets, 2001. "Uncertain Potential Output: Implications for Monetary Policy," Computing in Economics and Finance 2001 8, Society for Computational Economics.
  25. Jordi Gali & Mark Gertler, 2000. "Inflation Dynamics: A Structural Econometric Analysis," NBER Working Papers 7551, National Bureau of Economic Research, Inc.
  26. 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.
  27. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
  28. DeJong, David N & Ingram, Beth Fisher & Whiteman, Charles H, 1996. "A Bayesian Approach to Calibration," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(1), pages 1-9, January.
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  32. 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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  36. repec:cup:cbooks:9780521788885 is not listed on IDEAS
  37. Katharine S. Neiss & Edward Nelson, 2001. "The real interest rate gap as an inflation indicator," Bank of England working papers 130, Bank of England.
  38. Fuhrer, Jeffrey C & Moore, George R, 1995. "Monetary Policy Trade-offs and the Correlation between Nominal Interest Rates and Real Output," American Economic Review, American Economic Association, vol. 85(1), pages 219-39, March.
  39. Robert Miguel W. K. Kollman, 1997. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities; A Quantitative Investigation," IMF Working Papers 97/7, International Monetary Fund.
  40. DeJong, David N. & Ingram, Beth F. & Whiteman, Charles H., 2000. "A Bayesian approach to dynamic macroeconomics," Journal of Econometrics, Elsevier, vol. 98(2), pages 203-223, October.
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