Misspecification Tests on Taylor's Version of a Keynesian Macromodel

Abstract

Listen

Translate article

Taylor's macromodel [8], in common with other Keynesian models, has the fundamental property of imperfect price adjustment. The absence of instantaneous market clearing implies the possibility of effective demand failures and the non-neutrality of money [3]. The case for active monetary policy arises accordingly. The assumption of imperfect price adjustment is not testable in Taylor's model. However, other properties of the model which are implied by this assumption can be tested. This model also assumes that the moneystock is weakly exogenous with respect to the system formed of the equations determining price and output.' According to Engle, Hendry and Richard [5] a variable is defined as weakly exogenous if the inference can be conducted conditional on the sample values of the variable with no loss of relevant sample information. The assumption of weak exogeneity of the moneystock in Taylor's model validates conducting inference conditional on it and thus the model can be estimated without specifying an equation for the moneystock. It will be seen that restrictions on the price level and moneystock are testable along lines suggested by Engle [4]. These assumptions, if rejected, show crucial misspecifications of the Keynesian model considered. In section II definitions of weak exogeneity and predeterminedness are recalled. In section III a formal test for misspecification of Taylor's model [8] is derived based on the work of Engle [4]. The results are described in section IV. Finally there are concluding remarks in section V.