Economic Studies 88 Peter Welz Quantitative New
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ECONOMIC STUDIES 88 PETER WELZ QUANTITATIVE NEW KEYNESIAN MACROECONOMICS AND MONETARY POLICY PETER WELZ QUANTITATIVE NEW KEYNESIAN MACROECONOMICS AND MONETARY POLICY Department of Economics, Uppsala University Visiting address: Kyrkogårdsgatan 10, Uppsala, Sweden Postal address: Box 513, SE-751 20 Uppsala, Sweden Telephone: +46 18 471 11 06 Telefax: +46 18 471 14 78 Internet: http://www.nek.uu.se/ _____________________________________________________________________ ECONOMICS AT UPPSALA UNIVERSITY The Department of Economics at Uppsala University has a long history. The first chair in Economics in the Nordic countries was instituted at Uppsala University in 1741. The main focus of research at the department has varied over the years but has typically been oriented towards policy-relevant applied economics, including both theoretical and empirical studies. The currently most active areas of research can be grouped into six categories: x Labour economics x Public economics x Macroeconomics x Microeconometrics x Environmental economics x Housing and urban economics ______________________________________________________________________ Additional information about research in progress and published reports is given in our project catalogue. The catalogue can be ordered directly from the Department of Economics. © Department of Economics, Uppsala University ISBN 91-87268-95-7 ISSN 0283-7668 To my Mother Abstract Doctoral dissertation to be publicly examined in Horsal¨ 1, Ekonomikum, Uppsala University, 28 October, 2005, at 10.15 a.m. for the degree of Doctor of Philosophy. The examination will be held in English. WELZ, Peter, 2005, Quantitative New Keynesian Macroeconomics and Monetary Policy; Department of Economics, Uppsala University, Economic Studies 88, xviii, 128 pp., ISBN 91-87268-95-7. This thesis consists of four self-contained essays. Essay 1 compares the dynamic behaviour of an estimated New Keynesian sticky- price model with one-period delayed effects of monetary policy shocks to the dy- namics of a structural vector autoregression model. The model is estimated with Bayesian techniques on German pre-EMU data. The dynamics of the sticky-price model following either a demand shock or monetary policy shock are qualitatively and quantitatively comparable to those of the estimated structural VAR. When com- pared to the delayed-effects model, an alternative model with contemporaneous ef- fects of monetary policy is rejected according to the posterior-odds ratio criterion. Essay 2 addresses the transmission of exchange-rate variations in an estimated, small open-economy model. In contrast to the standard New Open Economy Macroeco- nomics framework, imported goods are treated here as material inputs to production. The resulting model structure is transparent and tractable while also able to account for imperfect pass through of exchange-rate shocks. The model is estimated with Bayesian methods on German data and the key finding is that a substantial depre- ciation of the nominal exchange rate leads to only modest effects on CPI inflation. An extended version of the model reveals that relatively small weight is placed on foreign consumption. Essay 3 (with Annika Alexius) analyses the strong responses of long-term interest rates to shocks that are difficult to explain with standard macroeconomic models. Augmenting the standard model to include a time-varying equilibrium real interest rate generates forward rates that exhibit considerable movement at long horizons in response to movements of the policy-controlled short rate. In terms of coefficients from regressions of long-rate changes on short-rate movements, incorporating a time- varying natural rate explains a significant fraction of the excess sensitivity puzzle. Essay 4 (with Par¨ Osterholm)¨ argues that the common finding of a large and signifi- cant coefficient on the lagged interest rate in Taylor rules may be the consequence of misspecification, specifically an omitted variables problem. Our Monte Carlo study shows that omitting relevant variables from the estimated Taylor rule can generate significant partial-adjustment coefficients, despite the data generating process con- taining no interest-rate smoothing. We further show that misspecification leads to considerable size distortions in two recently proposed tests to distinguish between interest-rate smoothing and serially-correlated disturbances. Peter Welz, Department of Economics, Uppsala University, P.O. Box 513, SE-75120 Uppsala, Sweden ISSN 0283-7668 ISBN 91-87268-95-7 Acknowledgements Writing one’s thesis is as much a product of intellectual discourse and collaboration as of lonely hours at the writing desk. As a result, I am grateful to many people. I would like to thank my supervisor, Nils Gottfries, for many insightful discussions, encouragement and support throughout my graduate studies. His valuable suggestions, comments and careful reading of initial drafts have helped transform these into essays that form this thesis. I am indebted to Annika Alexius for her ideas, collaboration and comments and to Anders Klevmarken for guiding me through the first year of the graduate programme. Over the course of my graduate studies I have also benefited from stimulating research environments at the Monetary Policy and the Research Departments at Sveriges Riksbank, the Department of Economics at Universitat Pompeu Fabra, the Econometric Modelling Unit of the Research Department at the European Central Bank, the Ifo Institute and the Department of Economics at the University of Munich. I would like to thank the staff at these institutions for their kind hospitality. I am particularly grateful to Ulrich Woitek for his invitations to Munich. I have appreciated and benefited from insightful discussions with Peter McAdam, Malin Adolfson, Ramon´ Adalid-Lozano, Mikael Carlsson, Kirsten Hubrich, Keith Kuster,¨ Frank Smets, Ulf Soderstr¨ om,¨ Roland Straub, Mathias Trabandt, Mattias Villani, Ulrich Woitek and my co-author, Par¨ Osterholm.¨ Sune Karlsson and Jesper Linde´ were kind enough to offer thorough comments on my work, leading to considerable improvements. In Fabio Canova, Sune Karlsson and Mark Steel I have found three excellent teachers who introduced me into the exciting field of Bayesian Statistics and Econometrics. Volker Clausen provided encouragement throughout my studies. Working for him as a research assistant while undergraduate student gave me the opportunity to share his enthusiasm for economic research and laid the basis for my decision to embark on a doctoral programme. The administrative staff at the department, especially Eva Holst, have shown utmost efficiency and professionalism. Many thanks also to Åke Qvarfort for providing excellent computing services, and beyond that, entertaining conversations. A thank you goes to my felIow students for lightening life as a graduate student: especially to Qian Liu, for inspiring and entertaining lunches, Mikael Nordberg for being a discussion partner during the night shifts and Hanna Ågren, Ranjula Bali Swain and Jovan Zamac for our talks ix x Acknowledgements beyond economics. In Alexandre Dmitriev I found an enthusiastic office mate, friend and team worker who keenly took on any intellectual discussion and contributed to finalising most mathematical proofs ‘q.e.d.’. Meredith Beechey carefully proofread the manuscript and provided valuable com- ments on Chapter 3. Financial support from the Jan Wallander and Tom Hedelius foun- dation, C. Borgstrom¨ and C. Berch’s Foundation, the Ifo Institute Munich and Centro de Estudios Monetarios y Financieros (CEMFI) Madrid, is gratefully acknowledged. Finally I am most grateful to Shanti, Uwe and my mother for their encouragement and support and their patient attempts to stabilise mood cycles. Without their help this project would not have reached this final stage. Peter Welz Frankfurt am Main, September 2005 Table of Contents Acknowledgements ix Introduction 1 1 Assessing Predetermined Expectations in the Standard Sticky Price Model: A Bayesian Approach 9 1.1 Introduction ................................. 9 1.2 The Sticky Price Model ........................... 11 1.2.1 Households ............................. 11 1.2.2 Firms ................................ 13 1.2.3 Central Bank ............................ 16 1.2.4 Solution of the Model ....................... 17 1.3 Estimation .................................. 18 1.3.1 Data ................................. 18 1.3.2 Estimation Methodology ...................... 19 1.3.3 Specification of Priors ....................... 21 1.4 Results .................................... 22 1.4.1 Parameter Estimates ........................ 22 1.4.2 Empirical Performance of the Model ................ 25 1.4.3 Impulse-Response Analysis .................... 28 1.4.4 Comparison to VAR ........................ 30 1.4.5 Comparison to a Model with Contemporaneous Effects ...... 31 1.4.6 Estimation Diagnostics ....................... 33 1.5 Summary and Conclusions ......................... 34 Appendices .................................... 36 A Model with Delays ............................. 36 A.1 Matrix Representation ....................... 36 B Bayesian Concepts ............................. 40 B.1 Metropolis-Hastings Algorithm .................. 40 B.2 Marginal Likelihood Computation................. 40 xi xii TABLE OF CONTENTS C Model with Contemporaneous Effects ................... 42 C.1 Estimation Results ......................... 42 C.2 Prior and Posterior Kernels ..................... 43 C.3 Impulse Responses ........................