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Monetary Policy Indeterminacy and Identification Failures in the US: Results from a Robust Test

Author

Listed:
  • Efrem Castelnuovo

    () (University of Padova)

  • Luca Fanelli

    () (University of Bologna)

Abstract

We propose a novel robust test to assess whether an estimated new-Keynesian model is consistent with a unique stable solution, as opposed to multiple equilibria. Our strategy is designed to handle identification failures as well as the misspecification of the relevant propagation mechanisms. We invert a likelihood ratio test for the cross-equation restrictions (CER) that the new-Keynesian system places on its reduced form solution under determinacy. If the CER are not rejected, we rule out the occurrence of sunspot-driven expectations from the model equilibrium and accept the structural model. Otherwise, we move to a second-step and invert, using the same grid considered in the first-step, an Anderson and Rubin-type test for the orthogonality restrictions (OR) implied by the system of Euler equations. We accept the hypothesis of indeterminacy if the OR are not rejected. We investigate the finite sample performance of the suggested two-steps testing strategy by some Monte Carlo experiments. Finally, we apply our robust test to a new-Keynesian AD/AS model estimated with actual U.S. post-WWII data. In spite of some evidence of weak identification as for the `Great Moderation' period, our results offer formal support to the hypothesis of a switch from indeterminacy to uniqueness occurred in the late 1970s.

Suggested Citation

  • Efrem Castelnuovo & Luca Fanelli, 2013. "Monetary Policy Indeterminacy and Identification Failures in the US: Results from a Robust Test," "Marco Fanno" Working Papers 0163, Dipartimento di Scienze Economiche "Marco Fanno".
  • Handle: RePEc:pad:wpaper:0163
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    References listed on IDEAS

    as
    1. Dufour, Jean-Marie & Khalaf, Lynda & Kichian, Maral, 2006. "Inflation dynamics and the New Keynesian Phillips Curve: An identification robust econometric analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 30(9-10), pages 1707-1727.
    2. Jean-Marie Dufour & Lynda Khalaf & Maral Kichian, 2009. "Structural Multi-Equation Macroeconomic Models: Identification-Robust Estimation and Fit," Staff Working Papers 09-19, Bank of Canada.
    3. Luca Benati & Paolo Surico, 2009. "VAR Analysis and the Great Moderation," American Economic Review, American Economic Association, vol. 99(4), pages 1636-1652, September.
    4. Fanelli, Luca, 2012. "Determinacy, indeterminacy and dynamic misspecification in linear rational expectations models," Journal of Econometrics, Elsevier, vol. 170(1), pages 153-163.
    5. West, Kenneth D., 1986. "Full-versus limited-information estimation of a rational-expectations model: Some numerical comparisons," Journal of Econometrics, Elsevier, vol. 33(3), pages 367-385, December.
    6. Dufour, Jean-Marie & Khalaf, Lynda & Kichian, Maral, 2013. "Identification-robust analysis of DSGE and structural macroeconomic models," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 340-350.
    7. Dufour, Jean-Marie & Khalaf, Lynda & Kichian, Maral, 2010. "On the precision of Calvo parameter estimates in structural NKPC models," Journal of Economic Dynamics and Control, Elsevier, vol. 34(9), pages 1582-1595, September.
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    Citations

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    Cited by:

    1. Giovanni Angelini & Luca Fanelli, 2016. "Misspecification and Expectations Correction in New Keynesian DSGE Models," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 78(5), pages 623-649, October.
    2. Caggiano, Giovanni & Castelnuovo, Efrem & Nodari, Gabriela, 2018. "Risk management-driven policy rate gap," Economics Letters, Elsevier, vol. 171(C), pages 235-238.
    3. Meinen, Philipp & Roehe, Oke, 2018. "To sign or not to sign? On the response of prices to financial and uncertainty shocks," Economics Letters, Elsevier, vol. 171(C), pages 189-192.
    4. Efrem Castelnuovo, 2019. "Yield curve and financial uncertainty: Evidence based on US data," CAMA Working Papers 2019-38, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    5. Luca Fanelli & Marco M. Sorge, 2015. "Indeterminacy, Misspecification and Forecastability: Good Luck in Bad Policy?," CSEF Working Papers 402, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    6. Castelnuovo, Efrem, 2016. "Modest macroeconomic effects of monetary policy shocks during the great moderation: An alternative interpretation," Journal of Macroeconomics, Elsevier, vol. 47(PB), pages 300-314.
    7. Giovanni Angelini & Paolo Gorgi, 2018. "DSGE Models with Observation-Driven Time-Varying parameters," Tinbergen Institute Discussion Papers 18-030/III, Tinbergen Institute.
    8. repec:eee:ecolet:v:171:y:2018:i:c:p:169-171 is not listed on IDEAS
    9. Farmer, Roger E.A. & Khramov, Vadim & Nicolò, Giovanni, 2015. "Solving and estimating indeterminate DSGE models," Journal of Economic Dynamics and Control, Elsevier, vol. 54(C), pages 17-36.
    10. Guido Ascari & Paolo Bonomolo & Hedibert Lopes, 2018. "Walk on the wild side: Multiplicative sunspots and temporarily unstable paths," DNB Working Papers 597, Netherlands Central Bank, Research Department.
    11. Guido Ascari & Paolo Bonomolo & Hedibert F. Lopes, 2016. "Rational Sunspots," Economics Series Working Papers 787, University of Oxford, Department of Economics.
    12. Chan, Joshua C.C. & Eisenstat, Eric, 2018. "Comparing hybrid time-varying parameter VARs," Economics Letters, Elsevier, vol. 171(C), pages 1-5.
    13. Krogh, Tord S., 2015. "Macro frictions and theoretical identification of the New Keynesian Phillips curve," Journal of Macroeconomics, Elsevier, vol. 43(C), pages 191-204.
    14. repec:eee:jmacro:v:53:y:2017:i:c:p:57-70 is not listed on IDEAS

    More about this item

    Keywords

    Confidence set; Determinacy; Identification failures; Indeterminacy; Misspecification; New-Keynesian Business Cycle Model; VAR System.;

    JEL classification:

    • C31 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models; Quantile Regressions; Social Interaction Models
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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