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Estimating forward-looking Euler equations with GMM estimators: an optimal-instruments approach

  • Jeffrey C. Fuhrer
  • Giovanni P. Olivei

We compare different methods for estimating forwardlooking output and inflation equations and show that weak identification can be an issue in conventional GMM estimation. GMM and maximum likelihood procedures that impose the dynamic constraints implied by the forwardlooking relation on the instruments set are found to be more reliable than conventional GMM. These “optimal instruments” procedures provide a robust alternative to estimating dynamic macroeconomic relations, and suggest only a limited role for expectational terms.

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File URL: http://www.federalreserve.gov/events/conferences/mmp2004/pdf/Fuhrer-Olivei.pdf
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Article provided by Board of Governors of the Federal Reserve System (U.S.) in its journal Proceedings.

Volume (Year): (2005)
Issue (Month): ()
Pages: 87-114

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Handle: RePEc:fip:fedgpr:y:2005:p:87-114
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  1. Jeffrey C. Fuhrer, 1995. "The [un]importance of forward-looking behavior in price specifications," Working Papers 95-6, Federal Reserve Bank of Boston.
  2. Glenn D. Rudebusch & Jeffrey C. Fuhrer, 2002. "Estimating the Euler equation for output," Working Paper Series 2002-12, Federal Reserve Bank of San Francisco.
  3. Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, vol. 17(3), pages 247-252.
  4. Stock, James H & Wright, Jonathan H & Yogo, Motohiro, 2002. "A Survey of Weak Instruments and Weak Identification in Generalized Method of Moments," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(4), pages 518-29, October.
  5. Cragg, John G. & Donald, Stephen G., 1993. "Testing Identifiability and Specification in Instrumental Variable Models," Econometric Theory, Cambridge University Press, vol. 9(02), pages 222-240, April.
  6. James H. Stock & Motohiro Yogo, 2002. "Testing for Weak Instruments in Linear IV Regression," NBER Technical Working Papers 0284, National Bureau of Economic Research, Inc.
  7. Arturo Estrella & Jeffrey C. Fuhrer, 2002. "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational-Expectations Models," American Economic Review, American Economic Association, vol. 92(4), pages 1013-1028, September.
  8. Jeffrey C. Fuhrer, 2000. "Habit Formation in Consumption and Its Implications for Monetary-Policy Models," American Economic Review, American Economic Association, vol. 90(3), pages 367-390, June.
  9. Sharon Kozicki & P.A. Tinsley, 1998. "Vector rational error correction," Research Working Paper 98-03, Federal Reserve Bank of Kansas City.
  10. Jordi Galí & Mark Gertler, 1998. "Inflation dynamics: A structural econometric analysis," Economics Working Papers 341, Department of Economics and Business, Universitat Pompeu Fabra.
  11. repec:cup:etheor:v:9:y:1993:i:2:p:222-40 is not listed on IDEAS
  12. Buiter, Willem H & Jewitt, Ian, 1981. "Staggered Wage Setting with Real Wage Relativities: Variations on a Theme of Taylor," The Manchester School of Economic & Social Studies, University of Manchester, vol. 49(3), pages 211-28, September.
  13. John Shea, 1996. "Instrument Relevance in Multivariate Linear Models: A Simple Measure," NBER Technical Working Papers 0193, National Bureau of Economic Research, Inc.
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