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Solving Forward-Looking Models of Cross-Country Adjustment within the Euro Area

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  • Andrzej Torój

    (Warsaw School of Economics and Ministry of Finance in Poland)

Abstract

This article introduces and applies two refinements to the algorithm of solving rational expectations models of a currency union. Firstly, building upon Klein (2000), it generalizes the standard methods of solving rational expectations models to the case of time-varying nonstochastic parameters, recurring in a finite cycle. Such a specification occurs in a simple stylized New Keynesian model of the euro area after a joint introduction of (i) rotation in the ECB Governing Council (as constituted by the Treaty of Nice) and (ii) home bias in the interest rate decisions preferred by its members. Secondly, we apply the method of Christiano (2002) to solve the model with heterogenous information sets. This is justified if we argue that the information set of domestic economic agents in a currency union is home-biased (i.e. foreign shocks enter only with a lag). Both methods of solution are illustrated with simulation results.

Suggested Citation

  • Andrzej Torój, 2009. "Solving Forward-Looking Models of Cross-Country Adjustment within the Euro Area," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 1(3), pages 211-241, November.
    • Handle: RePEc:psc:journl:v:1:y:2009:i:3:p:211-241
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    More about this item

    Keywords

    solving rational expectations models; generalized Schur decomposition; heterogenous information sets; method of Christiano; divergences in EMU;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F15 - International Economics - - Trade - - - Economic Integration

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