Aggregate Demand Equation Research Articles

A Small Scale Macroeconomic Model for Morocco

Abstract. In this research paper, we build a New Keynesian reduced-form macroeconomic model for Morocco. The model encompasses three main blocks: an aggregate demand equation (IS curve), a price-setting equation (Phillips curve) and a Taylor-type monetary policy rule. In our model, we consider a significant forward-looking component when explaining inflation dynamics, which enables us to include agent’s expectations. The downstream aim of this work is to provide the research community with new possibilities in terms of economic workhorse modelling, particularly for monetary policy analysis purposes. Keywords. Small scale model, Forward-looking expectations, Monetary policy, Fixed exchange regime. JEL. C32, E12, E17, E43, E47.

Time-varying equilibrium rates in small open economies: Evidence for Canada

This paper estimates equilibrium rates of macroeconomic aggregates for small open economies. We simultaneously identify the transitory and permanent components of output, inflation, the interest rate and the exchange rate by means of a multivariate trend-cycle decomposition. Realizations of the observed macroeconomic aggregates are explained in terms of unobserved equilibrium rates and unobserved transitory components. The transitory components of the variables are linked to each other through an aggregate demand equation, a Phillips curve, and an equation specifying the interest rate-exchange rate nexus. The model is then applied to Canadian data.

An open economy new Keynesian macroeconomic model: The case of Turkey

Makro iktisatta 1990’ların sonunda Yeni Neo-Klasik Sentez ya da Yeni Keynesyen Makroekonomik Model olarak adlandırılan yeni uzlaşı oluşmuştur. Bu uzlaşının temel özelliği Yeni Klasik, Reel İş Çevrimleri ve Yeni Keynesyen yaklaşımların sentezinden meydana gelmiş olmasıdır. Yeni Keynesyen Makroekonomik Model bir genel denge modeline dayanmakla beraber, toplam arz denklemi (Phillips Eğrisi), toplam talep denklemi (IS denklemi) ve bir para politikası kuralından oluşan üç denklemli bir sistem olarak da ifade edilebilmektedir. Temel model kapalı bir ekonomi varsaymaktadır. Bununla birlikte, Türkiye gibi büyümesi uluslararası sermaye hareketlerine bağlı küçük açık ekonomiler için, standart Yeni Neo-Klasik Sentez modelinin ekonomik dinamikleri açıklama yeteneği sınırlıdır. Bu çalışmada,standart bir Yeni Neo-Klasik Sentez modeli döviz kuru hareketlerini ve cari açık dinamiklerini dikkate alan denklemler eklenerek küçük bir açık ekonomi için genişletilmiştir. Elde edilen sonuçlar açık ekonomi Yeni Neo-Klasik Sentez modelinin finansal serbestleştirme sonrası Türkiye ekonomisinin dinamiklerini ve Türkiye Cumhuriyet Merkez Bankasının davranışlarını açıklamak için bir çerçeve olarak kullanılabileceğini göstermektedir.

Calvo vs. Rotemberg in a trend inflation world: An empirical investigation

This paper estimates and compares New-Keynesian DSGE monetary models of the business cycle derived under two different pricing schemes— Calvo (1983) and Rotemberg (1982)—under a positive trend inflation rate. Our empirical findings (i) support trend inflation as an empirically relevant feature of the U.S. great moderation; (ii) provide evidence in favor of the statistical superiority of the Calvo setting; (iii) point to a substantially lower degree of price indexation under Calvo. We show that the superiority of the Calvo model is due to the restrictions imposed by such a pricing scheme on the aggregate demand equation.

A Time-Varying Natural Rate for the Euro Area

In this article we estimate a time-varying natural rate of interest (TVNRI) for a synthetic euro area over the period 1979Q1-2002Q4 using a small backward-looking macroeconomic model, broadly following a methodology developed by Laubach and Williams (2003) for the United States. The Kalman filter simultaneously estimates two unobservable variables: the output gap and the natural rate of interest. The underlying state-space model incorporates an aggregate demand equation and a Phillips curve. Consistent with the theoretical intuition, our identifying assumptions include a close relationship between the TVNRI and the low-frequency fluctuations of potential output growth. The resulting interest rate gap, that is, the difference between the real rate of interest and its estimated natural level, provides us with a valuable tool for assessing the monetary policy stance in EU12 over the last two decades. While our TVNRI estimate seems quite robust to changes in model specifications, the relatively high uncertainty surrounding the estimate hampers its direct integration into the policy-making process.

Monetary Policy Rules Under Heterogeneous Inflation Expectations

This paper evaluates the role of inflation-forecast heterogeneity in US monetary policy making. The deviation between private and central bank inflation forecasts is identified as a factor increasing inflation persistence and thus calling for a policy reaction. An optimal policy rule is derived by the minimization under discretion of a standard central bank loss function subject to a Phillips curve, modified to include the forecast deviation, and a forward-looking aggregate demand equation. This rule, which itself includes the forecast deviation as an additional argument, is estimated for the period 1974-1998, covering the Chairmanships of Arthur Burns, Paul Volcker and Alan Greenspan, by using real-time forecasts of inflation and the output gap obtained from the FOMC’s Greenbook and the Survey of Professional Forecasters. The estimated rule remains remarkably stable over the whole sample period, challenging the conventional view of a structural break following Volcker’s appointment as Chairman of the Fed. Finally, the substantial decline in the significance of the interest-rate smoothing term in the rule indicates that monetary policy inertia may, to a large extent, be an artifact of serially correlated inflation-forecast errors that feed into policy decisions in real time.

Modeling the Components of Market Discipline

This paper evaluates the role of inflation-forecast heterogeneity in US monetary policy making. The deviation between private and central bank inflation forecasts is identified as a factor increasing inflation persistence and thus calling for a policy reaction. An optimal policy rule is derived by the minimization under discretion of a standard central bank loss function subject to a Phillips curve, modified to include the forecast deviation, and a forward-looking aggregate demand equation. This rule, which itself includes the forecast deviation as an additional argument, is estimated for the period 1974-1998, covering the Chairmanships of Arthur Burns, Paul Volcker and Alan Greenspan, by using real-time forecasts of inflation and the output gap obtained from the FOMC’s Greenbook and the Survey of Professional Forecasters. The estimated rule remains remarkably stable over the whole sample period, challenging the conventional view of a structural break following Volcker’s appointment as Chairman of the Fed. Finally, the substantial decline in the significance of the interest-rate smoothing term in the rule indicates that monetary policy inertia may, to a large extent, be an artifact of serially correlated inflation-forecast errors that feed into policy decisions in real time.

Travel to Canada: the role of Canada's immigrant populations

The effect of Canada's immigrant populations on the annual flow of visitors to Canada is investigated. A simple utility-maximizing model of the travel decision motivates the role of immigrant populations in the aggregate demand equation for visits to Canada. The model implies testable hypotheses: price and income elasticities differ by purpose of trip. Using time-series cross-section data on 22 OECD countries an empirical demand model is estimated. Demand is measured by both the number of visitors and person-nights and separate equations are estimated for four subcategories of ‘purpose of trip’. Immigrant populations are found to have a strong influence on the annual flow of foreign visitors. It is estimated that the present value of the stream of spending by foreign visitors attributable to an additional immigrant is approximately $4550 in 1996 dollars. In accordance with the model's predictions, price and income elasticity estimates are greater for vacationers than for those visiting family and friends.

On Modeling the Effects of Inflation Shocks

A popular model in the literature postulates an interest rate rule, a NAIRU price equation, and an aggregate demand equation in which aggregate demand depends on the real interest rate. In this model a positive inflation shock with the nominal interest rate held constant is explosive because it increases aggregate demand (because the real interest rate is lower), which increases inflation through the price equation, which further increases aggregate demand, and so on. In order for the model to be stable, the nominal interest rate must rise more than inflation, which means that the coefficient on inflation in the interest rate rule must be greater than one.

Forward-Looking Behavior and the Optimality of the Taylor Rule

This paper examines the optimal monetary policy under discretion using a small macroeconomic model that allows for varying degrees of forward-looking behavior. We quantify how forward-looking behavior affects the optimal response to inflation and the output gap in the central bank’s interest rate rule. Specifically, we isolate the influence of forwardlooking behavior in the aggregate demand equation, the wage contracting equation, and the term structure equation. We show that the data cannot uniquely identify the degree of forward-looking behavior in this class of models. Nevertheless, by imposing some assumptions about forward-looking behavior that are motivated by economic theory, we show that a plausible set of parameters can deliver the Taylor rule as the optimal monetary policy under discretion. We find that a successful parameter combination must include one or more of the following: (i) a high degree forward-looking behavior in the aggregate demand equation, (ii) a low degree of forward looking-behavior in the term structure equation, or (iii) a large (but still plausible) interest rate sensitivity parameter in the aggregate demand equation.

Forward-Looking Behavior and the Optimality of the Taylor Rule

This paper examines the optimal monetary policy under discretion using a small macroeconomic model that allows for varying degrees of forward-looking behavior. We quantify how forward-looking behavior affects the optimal response to inflation and the output gap in the central bank's interest rate rule. Specifically, we isolate the influence of forward-looking behavior in the aggregate demand equation, the wage contracting equation, and the term structure equation. We show that the data cannot uniquely identify the degree of forward-looking behavior in this class of models. Nevertheless, by imposing some assumptions about forward-looking behavior that are motivated by economic theory, we show that a plausible set of parameters can deliver the Taylor rule as the optimal monetary policy under discretion. We find that a successful parameter combination must include one or more of the following: (i) a high degree forward-looking behavior in the aggregate demand equation, (ii) a low degree of forward-looking behavior in the term structure equation, or (iii) a large (but still plausible) interest rate sensitivity parameter in the aggregate demand equation. More generally, our results show that a plausible set of model parameters can erase the distinction between instrument rules (such as the Taylor rule) and so-called targeting rules that represent the solution to a particular loss-minimization problem assigned to the central bank.

A Globally Flexible, Almost Ideal Demand System

The almost ideal demand system is combined with the Fourier expenditure system. Subject to the assumption that preferences are of the price-independent, generalized-logarithmic class, the resulting demand system has the desirable features of each of its components. Aggregate demand equations are consistent with preferences of a representative consumer, and consistent estimates of elasticities are obtained for all observed prices. Application of the new demand system to U.S. consumption of meats and fish reveals that it fits the data well and that the restriction to the usual specification is rejected.

Bottlenecks and the Phillips Curve: A Disaggregated Keynesian Model of Inflation, Output and Unemployment

Benchmark macroeconomic models of output and inflation combine the demand side of the economy with aggregate supply equations based upon some version of the Phillips curve. In contrast to classical and new classical models such as Lucas (I972) and Sargent (1979, chs. i, xii and xvi), in which prices jump instantaneously to market clearing levels, the gradual price-adjustment approach represented by Tobin (1972), Laidler and Parkin (I975, section 4), Barro and Grossman (1976, ch. 5), Sargent (1979, ch. ii and ch. v.i), Okun (I98I), and Perry (I983) take wages and/or prices to be predetermined at an instant in time while their rates of change depend on the level of aggregate output. In the prototype complete macroeconomic model incorporating this approach, output is determined by aggregate demand equations while the augmented Phillips curve specifies that prices move in a direction which will tend to return output to its equilibrium value. This short-run Keynesian, long-run monetarist character is typical of many structural macroeconometric models. It is the standard textbook account found, for example, in Dornbusch and Fischer (I98I) and is implicit in much current research. There are fundamental questions of consistency in the type of model just described. The central difficulty is that, with wages and prices predetermined, the non-market-clearing analysis ofBarro and Grossman (I 976, ch. 2) and Malinvaud (I977) is applicable. But in this world the aggregate demand equations are decisive only in the Keynesian regime: in the other regimes, which must arise at high levels of aggregate demand, the effective supplies of output or labour or both must be modelled. Indeed, at the aggregate level it is difficult to provide a coherent account of how it is possible to have output above its equilibrium value since this would require labour and output in excess of their notional supplies, violating Barro and Grossman's 'min' condition that quantities be determined by the short side of the market. An appealing line for addressing this last difficulty is to disaggregate markets, an approach taken by Hansen (I970), Tobin (I972) and Barro and Grossman (I976, ch. 5). However, because each market can be in either excess supply or demand, a formal fixed-price general equilibrium model appears to be intractable, due to the resulting multiplicity of regimes, and is not attempted by these authors. In this paper these problems are overcome in a disaggregated model in which

Fuel choice and aggregate energy demand in the residential and commercial sectors

The energy demand response of the residential and commercial sectors to fuel price changes is of increasing importance to public policy makers. In this paper, the demands for energy in both sectors are examined separately using a refined data base. For each sector, a multinomial logit formulation is utilized, along with an aggregate demand equation to determine analytically short- and long-run fuel price elasticities of demand for the major fuels consumed. It is found that increases in energy prices have a greater effect on energy demand in the commercial sector. Furthermore, in both sectors, raising electricity prices has a greater effect for conserving energy (both end-use and primary) than do equal price rises for natural gas or heating oils.