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Toward a modern macroeconomic model usable for policy analysis

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  • Eric M. Leeper
  • Christopher A. Sims

Abstract

This paper presents a macroeconomic model that is both a completely specified dynamic general equilibrium model and a probabilistic model for time series data. We view the model as a potential competitor to existing ISLM-based models that continue to be used for actual policy analysis. Our approach is also an alternative to recent efforts to calibrate real business cycle models. In contrast to these existing models, the one we present embodies all the following important characteristics: i) It generates a complete multivariate stochastic process model for the data it aims to explain, and the full specification is used in the maximum likelihood estimation of the model; ii) It integrates modeling of nominal variables -- money stock, price level, wage level, and nominal interest rate -- with modeling real variables; iii) It contains a Keynesian investment function, breaking the tight relationship of the return on investment with the capital-output ratio; iv) It treats both monetary and fiscal policy explicitly; v) It is based on dynamic optimizing behavior of the private agents in the model. Flexible-price and sticky-price versions of the model are estimated and their fits are evaluated relative to a naive model of no-change in the variables and to an unrestricted VAR. The paper displays the model's implications for the dynamic responses to structural shocks, including policy shocks, and evaluates the relative importance of various shocks for determining economic fluctuations.
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Suggested Citation

  • Eric M. Leeper & Christopher A. Sims, 1994. "Toward a modern macroeconomic model usable for policy analysis," FRB Atlanta Working Paper 94-5, Federal Reserve Bank of Atlanta.
  • Handle: RePEc:fip:fedawp:94-5
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    References listed on IDEAS

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    1. Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, vol. 69(2), pages 108-113, May.
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    4. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February.
    5. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-1370, November.
    6. Sims, Christopher A & Uhlig, Harald, 1991. "Understanding Unit Rooters: A Helicopter Tour," Econometrica, Econometric Society, vol. 59(6), pages 1591-1599, November.
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    8. Altug, Sumru, 1989. "Time-to-Build and Aggregate Fluctuations: Some New Evidence," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(4), pages 889-920, November.
    9. Evan F. Koenig, 1993. "Rethinking the IS in IS-LM: adapting Keynesian tools to non-Keynesian economies Part 2," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Dec, pages 17-35.
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    More about this item

    Keywords

    Econometric models; Macroeconomics;

    JEL classification:

    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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