Econometric Policy Evaluation in a Two Sector Model

Abstract

This paper estimates a New-Keynesian structural model and evaluates alternative monetary policy regimes. An estimated two sector model and alternative policy regimes are used to calculate the optimal monetary policy frontier. The structural model that consists of two sectors: durable and nondurable, is estimated by the Full Information Maximum Likelihood (FIML) method. Given the structure of the economy and discretionary monetary policy regimes, we find that changes in monetary policy responses to aggregate or disaggregate inflation and output gap can imply substantial differences in long-run inflation and output variances. More importantly, this paper shows that in terms of monetary policy frontier, monetary policy could have been more effective if the central bank had focused on sectoral stabilization as opposed to traditional stabilization.