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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. Peter N. Ireland, 2001. "Money's Role in the Monetary Business Cycle," NBER Working Papers 8115, National Bureau of Economic Research, Inc.
  2. Svensson, Lars & Woodford, Michael, 2000. "Indicator Variables for Optimal Policy," Seminar Papers 688, Stockholm University, Institute for International Economic Studies.
  3. Gert Peersman & Frank Smets, 2005. "The Industry Effects of Monetary Policy in the Euro Area," Economic Journal, Royal Economic Society, vol. 115(503), pages 319-342, 04.
  4. 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.
  5. Jordi Gali, 2002. "New Perspectives on Monetary Policy, Inflation, and the Business Cycle," NBER Working Papers 8767, National Bureau of Economic Research, Inc.
  6. 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.
  7. Ireland, Peter N., 2004. "A method for taking models to the data," Journal of Economic Dynamics and Control, Elsevier, vol. 28(6), pages 1205-1226, March.
  8. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  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.
  10. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
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  12. Blanchard, Olivier Jean & Quah, Danny, 1989. "The Dynamic Effects of Aggregate Demand and Supply Disturbances," American Economic Review, American Economic Association, vol. 79(4), pages 655-73, September.
  13. 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.
  14. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  15. Jeffery D. Amato & Thomas Laubach, 2002. "Rule-of-thumb behaviour and monetary policy," Finance and Economics Discussion Series 2002-5, Board of Governors of the Federal Reserve System (U.S.).
  16. 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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  18. 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.
  19. Peter N. Ireland, 1999. "Interest Rates, Inflation, and Federal Reserve Policy Since 1980," Boston College Working Papers in Economics 419, Boston College Department of Economics.
  20. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
  21. Jeff Fuhrer, 2000. "Optimal Monetary Policy In A Model With Habit Formation," Computing in Economics and Finance 2000 306, Society for Computational Economics.
  22. Nelson, Edward, 2002. "Direct effects of base money on aggregate demand: theory and evidence," Journal of Monetary Economics, Elsevier, vol. 49(4), pages 687-708, May.
  23. Casares, Miguel & McCallum, Bennett T., 2006. "An optimizing IS-LM framework with endogenous investment," Journal of Macroeconomics, Elsevier, vol. 28(4), pages 621-644, December.
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  26. 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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  32. 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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  34. Jón Steinsson, 2000. "Optimal monetary policy in an economy with inflation persistence," Economics wp11, Department of Economics, Central bank of Iceland.
  35. 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. 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.
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