Posted

September 27, 2010 11:43:04 PM

Date

2010-09

Author

Stéphane Dées, M. Hashem Pesaran, L. Vanessa Smith, Ron P. Smith

Affiliation

European Central Bank, Cambridge University, Birkbeck College

Title

Supply, demand and monetary policy shocks in a multi-country New Keynesian Model

Summary /
Abstract

This paper estimates and solves a multi-country version of the standard DSGE New Keynesian (NK) model. The country-specific models include a Phillips curve determining inflation, an IS curve determining output, a Taylor Rule determining interest rates, and a real effective exchange rate equation. The IS equation includes a real exchange rate variable and a countryspecific foreign output variable to capture direct inter-country linkages. In accord with the theory all variables are measured as deviations from their steady states, which are estimated as long-horizon forecasts from a reduced-form cointegrating global vector autoregression. The resulting rational expectations model is then estimated for 33 countries on data for 1980Q1-2006Q4, by inequality constrained IV, using lagged and contemporaneous foreign variables as instruments, subject to the restrictions implied by the NK theory. The multi-country DSGE NK model is then solved to provide estimates of identified supply, demand and monetary policy shocks. Following the literature, we assume that the within country supply, demand and monetary policy shocks are orthogonal, though shocks of the same type (e.g. supply shocks in different countries) can be correlated. We discuss estimation of impulse response functions and variance decompositions in such large systems, and present estimates allowing for both direct channels of international transmission through regression coefficients and indirect channels through error spillover effects. Bootstrapped error bands are also provided for the cross country responses of a shock to the US monetary policy.

Keywords

Global VAR (GVAR), New Keynesian DSGE models, supply shocks, demand shocks, monetary policy shocks.

URL

http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1239.pdf

Remarks

This adds to the toolkit that includes the Global Projection Model (GPM) and the Global Integrated Monetary and Fiscal Model (GIMF) developed at the IMF, which are estimated using Bayesian techniques, whereas the paper by Dees et al uses constrained instrumental variables. Both are versions of DSGE NK models. The IMF global models can be found in http://www.douglaslaxton.org/index.html.

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