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Parameter Identification in a Estimated New Keynesian Open Economy Model

  • Adolfson, Malin

    ()

    (Monetary Policy Department, Central Bank of Sweden)

  • Lindé, Jesper

    ()

    (Division of International Finance)

In this paper, we use Monte Carlo methods to study the small sample properties of the classical maximum likelihood (ML) estimator in artificial samples generated by the New- Keynesian open economy DSGE model estimated by Adolfson et al. (2008) with Bayesian techniques. While asymptotic identification tests show that some of the parameters are weakly identified in the model and by the set of observable variables we consider, we document that ML is unbiased and has low MSE for many key parameters if a suitable set of observable variables are included in the estimation. These findings suggest that we can learn a lot about many of the parameters by confronting the model with data, and hence stand in sharp contrast to the conclusions drawn by Canova and Sala (2009) and Iskrev (2008). Encouraged by our results, we estimate the model using classical techniques on actual data, where we use a new simulation based approach to compute the uncertainty bands for the parameters. From a classical viewpoint, ML estimation leads to a significant improvement in fit relative to the log-likelihood computed with the Bayesian posterior median parameters, but at the expense of some the ML estimates being implausible from a microeconomic viewpoint. We interpret these results to imply that the model at hand suffers from a substantial degree of model misspecification. This interpretation is supported by the DSGE-VAR() analysis in Adolfson et al. (2008). Accordingly, we conclude that problems with model misspecification, and not primarily weak identification, is the main challenge ahead in developing quantitative macromodels for policy analysis.

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Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 251.

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Length: 49 pages
Date of creation: 01 Apr 2011
Date of revision:
Handle: RePEc:hhs:rbnkwp:0251
Contact details of provider: Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden
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  1. Altig, David E & Christiano, Lawrence J. & Eichenbaum, Martin & Lindé, Jesper, 2005. "Firm-Specific Capital, Nominal Rigidities and the Business Cycle," CEPR Discussion Papers 4858, C.E.P.R. Discussion Papers.
  2. Iskrev, Nikolay, 2010. "Local identification in DSGE models," Journal of Monetary Economics, Elsevier, vol. 57(2), pages 189-202, March.
  3. Alejandro Justiniano & Bruce Preston, 2009. "Monetary policy and uncertainty in an empirical small open economy model," Working Paper Series WP-09-21, Federal Reserve Bank of Chicago.
  4. Malin Adolfson & Stefan Laseen & Jesper Lindé & Mattias Villani, 2005. "An estimated New Keynesian small open economy model," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
  5. Adolfson, Malin & Laseen, Stefan & Linde, Jesper & Villani, Mattias, 2007. "Bayesian estimation of an open economy DSGE model with incomplete pass-through," Journal of International Economics, Elsevier, vol. 72(2), pages 481-511, July.
  6. Christopher J. Erceg & Luca Guerrieri & Christopher Gust, 2006. "SIGMA: A New Open Economy Model for Policy Analysis," International Journal of Central Banking, International Journal of Central Banking, vol. 2(1), March.
  7. Jesus Fernandez-Villaverde & Juan F. Rubio-Ramirez, 2004. "Estimating Dynamic Equilibrium Economies: Linear versus Nonlinear Likelihood," PIER Working Paper Archive 04-005, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  8. Fabio Canova & Luca Sala, 2006. "Back to square one: identification issues in DSGE models," Computing in Economics and Finance 2006 196, Society for Computational Economics.
  9. Duarte, Margarida & Stockman, Alan C., 2005. "Rational speculation and exchange rates," Journal of Monetary Economics, Elsevier, vol. 52(1), pages 3-29, January.
  10. Vicente Tuesta & Pau Rabanal, 2006. "Euro-Dollar Real Exchange Rate Dynamics in an Estimated Two-Country Model; What is Important and What is Not," IMF Working Papers 06/177, International Monetary Fund.
  11. Riccardo Cristadoro & Andrea Gerali & Stefano Neri & Massimiliano Pisani, 2008. "Real exchange rate volatility and disconnect: an empirical investigation," Temi di discussione (Economic working papers) 660, Bank of Italy, Economic Research and International Relations Area.
  12. Malin Adolfson & Stefan Laséen & Jesper Lindé & Mattias Villani, 2005. "The Role of Sticky Prices in an Open Economy DSGE Model: A Bayesian Investigation," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 444-457, 04/05.
  13. David Domeij & Martin Floden, 2006. "The Labor-Supply Elasticity and Borrowing Constraints: Why Estimates are Biased," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(2), pages 242-262, April.
  14. Thomas Lubik & Frank Schorfheide, 2005. "A Bayesian Look at New Open Economy Macroeconomics," Economics Working Paper Archive 521, The Johns Hopkins University,Department of Economics.
  15. Houtan Bastani & Luca Guerrieri, 2008. "On the application of automatic differentiation to the likelihood function for dynamic general equilibrium models," International Finance Discussion Papers 920, Board of Governors of the Federal Reserve System (U.S.).
  16. Anderson, Gary & Moore, George, 1985. "A linear algebraic procedure for solving linear perfect foresight models," Economics Letters, Elsevier, vol. 17(3), pages 247-252.
  17. Mumtaz, Haroon & Zabczyk, Pawel & Ellis, Colin, 2009. "What lies beneath: what can disaggregated data tell us about the behaviour of prices?," Bank of England working papers 364, Bank of England.
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