Keynesian Dynamic Stochastic General Equilibrium Research Articles

Endogenous innovation under New Keynesian dynamic stochastic general equilibrium model

ABSTRACTThis paper constructs an endogenous growth model using the framework of New Keynesian dynamic stochastic general equilibrium models. We incorporate the Schumpeterian approach that generates seemingly sticky prices and reinterpret the Calvo mechanism from the perspective of Bertrand competition and successful entrepreneurs. Our results demonstrate that both positive productivity shocks and endogenous innovation have a negative effect on subsequent endogenous innovation. These self-destructive effects of endogenous innovation might account for the IT productivity paradox and productivity slowdown seen in advanced countries. Furthermore, it is shown that there are both neutral and non-neutral properties of monetary policy shocks. They are neutral in terms of the growth effect, but non-neutral in terms of the level effect. In particular, expansionist monetary policies are desirable to facilitate endogenous innovation.

TECHNOLOGY SHOCKS AND BUSINESS CYCLES IN INDIA

In this paper, we develop a small open economy New Keynesian dynamic stochastic general equilibrium (DSGE) model to understand the relative importance of two key technology shocks, Hicks neutral total factor productivity (TFP) shock and investment specific technology (IST) shock for an emerging market economy like India. In addition to these two shocks, our model includes three demand side shocks such as fiscal spending, home interest rate, and foreign interest rate. Using a Bayesian approach, we estimate our DSGE model with Indian annual data for key macroeconomic variables over the period of 1971–2010, and for subsamples of pre-liberalization (1971–1990) and post-liberalization (1991–2010) periods. Our study reveals three main results. First, output correlates positively with TFP, but negatively with IST. Second, TFP and IST shocks are the first and the second most important contributors to aggregate fluctuations in India. In contrast, the demand side disturbances play a limited role. Third, although TFP plays a major role in determining aggregate fluctuations, its importance vis-à-vis IST has declined during the post liberalization era. We find that structural shifts of nominal friction and relative home bias for consumption to investment in the post-liberalization period can account for the rising importance of the IST shocks in India.

OIL PRICE SHOCKS, INFLATION, AND CHINESE MONETARY POLICY

This paper proposes a New Keynesian dynamic stochastic general equilibrium model of the Chinese economy incorporating the demand of oil to study the effects of oil price shocks on the business cycle. The model answers several questions, including how monetary policy should respond to the disturbances from such shocks, and whether monetary authorities should use core inflation or headline inflation including oil price inflation as the monetary policy rule. The contributions could be summarized as follows: First, the model reveals that the oil transmission mechanism is determined by the nominal inertia, income effect, and the portfolio allocation effect. Second, both noncore inflation monetary policy and core inflation monetary policy that are simultaneously pegged to oil prices fluctuations are inferior to the monetary policy purely pegged to core inflation. Our findings suggest that the monetary policy should focus on core inflation instead of headline inflation.

MONETARY AND MACROPRUDENTIAL POLICIES UNDER FIXED AND VARIABLE INTEREST RATES

In this paper, I analyze the ability of monetary policy to stabilize both the macroeconomy and financial markets under two different scenarios: fixed- and variable-rate mortgages. I develop and solve a new Keynesian dynamic stochastic general equilibrium model (DSGE) that features a housing market and a group of constrained individuals who need housing collateral to obtain loans. A given share of constrained households borrows at a variable rate, whereas the rest borrow at a fixed rate. I consider two alternative ways of introducing a macroprudential approach to enhancing financial stability: one in which monetary policy, using the interest rate as an instrument, responds to credit growth; and a second one in which the macroprudential instrument is instead the loan-to-value ratio (LTV). The results show that when rates are variable, a countercyclical LTV rule performs better in stabilizing financial markets than monetary policy. However, when rates are fixed, even though monetary policy is less effective in stabilizing the macroeconomy, it does a good job in promoting financial stability.

How the Wealth and Credit Channels in Monetary Transmission Affect Consumer Durables and Housing: A Dynamic Stochastic General Equilibrium Approach

This study investigates the effects of the wealth and credit channels of monetary transmission mechanisms on consumer durables spending and housing investment. A New Keynesian Dynamic Stochastic General Equilibrium model that incorporates financial frictions is used to derive impulse response functions. The results indicate strong evidence for an amplifying effect of financial frictions on aggregate economic activity. Output, spending on consumer durable goods, housing investment, housing prices, and household wealth respond positively and significantly to a 50-basis point cut in the federal funds rate. The wealth channel is only found to have marginal effects upon household spending.

Declined effectiveness of fiscal and monetary policies faced with aging population in Japan

This paper studies how population aging affects economic performance and the effectiveness of fiscal and monetary policies. We develop a New Keynesian dynamic stochastic general equilibrium model with heterogeneous households: workers and retirees. We demonstrate that an increase in the proportion of working population increases aggregate output, consumption, and investment by increasing total labor supply in the long run. It also increases wages and reduces the social security burden of the government. This paper also finds that the effectiveness of fiscal and monetary policies is weakened when the proportion of retirees becomes larger.

Nowcasting GDP Growth for Small Open Economies with a Mixed-Frequency Structural Model

This paper proposes a mixed-frequency small open economy structural model, in which the structure comes from a New Keynesian dynamic stochastic general equilibrium (DSGE) model. An aggregation rule is proposed to link the latent aggregator to the observed quarterly output growth via aggregation. The resulting state-space model is estimated by the Kalman filter and the estimated current aggregator is used to nowcast the quarterly GDP growth. Taiwanese data from January 1998 to December 2015 are used to illustrate how to implement the technique. The DSGE-based mixed-frequency model outperforms the reduced-form mixed-frequency model and the MIDAS model on nowcasting Taiwan’s quarterly GDP growth.

Is fiscal expansion more effective in a financial crisis?

ABSTRACTAfter the Great Recession, the Keynesian expansionary policy has been regarded as an effective measure, especially under imperfect financial market conditions. Among literature related to fiscal policy in financial crises, Fernández-Villaverde (2010) suggests that the fiscal policy multiplier increases in a financial crisis through the Fisher effect. However, we should note that the author simply compared the multiplier computed in the standard new Keynesian dynamic stochastic general equilibrium (DSGE) with that in the DSGE with financial accelerator settings. As the financial accelerator is considered effective during both financial crises and normal financial conditions, the author’s comparison should be considered insignificant for showing a greater multiplier in the financial crisis. In this study, to make the exact comparison, we first estimate parameters regarding the Fisher effect under each regime separately and then compute and compare the estimated fiscal multipliers using these 2 estimates in the same DSGE model. Using Japanese financial data that provide enough observations under the good and bad regimes of financial conditions, we find that fiscal multipliers are smaller in the bad regime than in the good regime.

Optimal Fiscal Policy in a Liquidity Trap at the Zero Lower Bound

We build on a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to explore the macroeconomic consequences of fiscal expansionary shocks during the economic crisis of 2008 in the eurozone. In this setting, we find that the big four eurozone economies (France, Germany, Italy, and Spain) can effectively escape from their liquidity trap through fiscal policy interventions caused by government purchases. We estimate the government spending multiplier to be above 1.8 when this policy is associated with a long-term commitment to keeping the nominal interest rate at the zero lower bound, as suggested by Krugman (1998). Notably, the short-term deficit effect on the budget balance can be offset five years after the implementation of a large spending program. We also show that alternative policies with tax cuts that expand the supply do not appear to have the same power in the short run. Moreover, we provide novel empirical evidence that a large government debt renders a government spending policy ineffective.

Версия элементарной неомарксистской модели экономических колебаний

The world economic and financial crisis has revealed the weakness of modern economics mainstream theories and the related models in explaining the capitalist economy dynamics. These are first of all real business cycles and New Keynesian dynamic stochastic general equilibrium models. They treat economic fluctuations as a result of unexpected shocks. The Marx's reproduction theory can become an alternative as it analyses cyclicality as an immanent feature of the capitalist mode of production arising from fundamental contradictions between labour and capital. Some of its concepts have been formalized in the predator-prey Class-Struggle Model by R. Goodwin. The model was a theoretical tool to investigate interactions between changes in employment rate (a labour market indicator) and share of labour in national income (representing a distribution of the value produced between workers and capitalists). Nevertheless, nor it neither subsequent modifications were empirically valid. Researchers who tried to verify the models by bringing them to data have pointed to a misspecification as a possible reason. To our mind, the point is that the models by R. Goodwin and his disciples reflect a distributive conflict between labour and capital which is subordinate to the main contradiction regarding production relations. The article states a prey-predator type model version based on the reproduction theory by K. Marx. The variables are productive capital and surplus value which change in time along damped oscillations trajectories. Within the present framework the economic dynamics is seen as a subsequence of damped fluctuations each of which is characterised by own specific parameters (amplitude, duration), which in turn depend on fostered innovations and their diffusion in the economy.

Real estate price and heterogeneous investment behavior in China

We study the dynamic link between real estate prices and firms' investment behaviors in China using a new Keynesian dynamic stochastic general equilibrium model. The model features heterogeneous production sectors in which private firms face discriminatory borrowing constraints while state-owned firms are not. Fitted to China's quarterly data from 2005Q3 to 2014Q4, the quantitative general equilibrium model enables us to identify the driving forces behind and the macroeconomic variables interacting with land price. It confirms the existence of the “collateral channel” in the private sector without bearing the potential endogeneity problems in empirical studies. More importantly, we identify a “crowding out” channel between private and state-owned firms caused by discriminatory financial constraints. The “crowding out” channel implies a negative relationship between real estate prices and the investment of state-owned firms, which has been documented in empirical research but short of explanation so far.

MONEY AND MONETARY POLICY IN THE EUROZONE: AN EMPIRICAL ANALYSIS DURING CRISES

This paper analyzes the role of money and monetary policy as well as the forecasting performance of New Keynesian dynamic stochastic general equilibrium models with and without separability between consumption and money. The study is conducted over three crisis periods in the Eurozone, namely, the ERM crisis, the dot-com crisis, and the global financial crisis (GFC). The results of successive Bayesian estimations demonstrate that during these crises, the nonseparable model generally provides better out-of-sample output forecasts than the baseline model. We also demonstrate that money shocks have some impact on output variations during crises, especially in the case of the GFC. Furthermore, the response of output to a money shock is more persistent during the GFC than during the other crises. The impact of monetary policy also changes during crises. Insofar as the GFC is concerned, this impact increases at the beginning of the crisis, but decreases sharply thereafter.

Financial stability, wealth effects and optimal macroeconomic policy combination in the United Kingdom: A new-Keynesian dynamic stochastic general equilibrium framework

This study derives an optimal macroeconomic policy combination for financial sector stability in the United Kingdom by employing a New Keynesian Dynamic Stochastic General Equilibrium (NK-DSGE) framework. The empirical results obtained show that disciplined fiscal and accommodative monetary policies stance is optimal for financial sector stability. Furthermore, fiscal indiscipline countered by contractionary monetary stance adversely affects financial sector stability. Financial markets, e.g. stocks and Gilts show a short-term asymmetric response to macroeconomic policy interaction and to each other. The asymmetry is a reflection of portfolio adjustment. However in the long-run, the responses to suggested optimal policy combination had homogenous effects and there was evidence of co-movement in the stock and Gilt markets.

Short and long-term interest rates and the effectiveness of monetary and macroprudential policies

In this paper, I analyze the ability of monetary and macroprudential policies to stabilize both the macroeconomy and financial markets under two different scenarios: short and long-term rates. I develop and solve a New Keynesian dynamic stochastic general equilibrium model that features a housing market, borrowers and savers. Borrowers can access credit markets through their housing collateral. I consider two alternative ways of introducing a macroprudential approach to enhance financial stability: one in which monetary policy, using the interest rate as an instrument, responds to credit growth; and a second one in which the macroprudential instrument is instead the loan-to-value ratio (LTV). Results show that monetary and macroprudential policies are less effective with long-term rates. However, in the short-term case, monetary policy can achieve the financial stability goal only at the expense of higher macroeconomic volatility. If the macroprudential policy is implemented using an LTV rule, financial stability improves significantly with short-term rates but just marginally with long-term ones.

A Predictive Likelihood Approach to Bayesian Averaging

Multivariate time series forecasting is applied in a wide range of economic activities related to regional competitiveness and is the basis of almost all macroeconomic analysis. In this paper we combine multivariate density forecasts of GDP growth, inflation and real interest rates from four various models, two type of Bayesian vector autoregression (BVAR) models, a New Keynesian dynamic stochastic general equilibrium (DSGE) model of small open economy and DSGE-VAR model. The performance of models is identified using historical dates including domestic economy and foreign economy, which is represented by countries of the Eurozone. Because forecast accuracy of observed models are different, the weighting scheme based on the predictive likelihood, the trace of past MSE matrix, model ranks are used to combine the models. The equal-weight scheme is used as a simple combination scheme. The results show that optimally combined densities are comparable to the best individual models.

Frequentist Evaluation of Small DSGE Models

This article proposes a new evaluation approach for the class of small-scale “hybrid” new Keynesian dynamic stochastic general equilibrium (NK-DSGE) models typically used in monetary policy and business cycle analysis. The empirical assessment of the NK-DSGE model is based on a conditional sequence of likelihood-based tests conducted in a vector autoregressive (VAR) system, in which both the low- and high-frequency implications of the model are addressed in a coherent framework. If the low-frequency behavior of the original time series of the model can be approximated by nonstationary processes, stationarity must be imposed by removing the stochastic trends. This gives rise to a set of recoverable unit roots/cointegration restrictions, in addition to the short-run cross-equation restrictions. The procedure is based on the sequence “LR1→LR2→LR3,” where LR1 is the cointegration rank test, LR2 is the cointegration matrix test, and LR3 is the cross-equation restrictions test: LR2 is computed conditional on LR1 and LR3 is computed conditional on LR2. The Type I errors of the three tests are set consistently with a prefixed overall nominal significance level. A bootstrap analog of the testing strategy is proposed in small samples. We show that the information stemming from the individual tests can be used constructively to uncover which features of the data are not captured by the theoretical model and thus to rectify, when possible, the specification. We investigate the empirical size properties of the proposed testing strategy by a Monte Carlo experiment and show the empirical usefulness of our approach by estimating and testing a monetary business cycle NK-DSGE model using U.S. quarterly data. Supplementary materials for this article are available online.

Does the Central Bank Respond to Credit Market Factors? A Bayesian DSGE Approach

This paper estimates a version of a New Keynesian Dynamic Stochastic General Equilibrium model with financial frictions for the United States using Bayesian techniques. Various Henderson-McKibbin-Taylor style monetary policy rules are examined, which react to inflation, output and credit market factors including credit spreads, financial leverage and credit growth. The central question is whether the central bank responds to credit market factors in setting the policy interest rate, which is investigated using posterior odds tests. The paper explores whether there is evidence of stabilization, if indeed the central bank is responding to credit market factors. This is conducted using impulse response analysis and an examination of parameter posterior distributions. The most compelling result during the period under study is the US Fed responded to credit spreads in setting the policy rate. The empirical results also confirm that credit spreads offer stabilization benefits. This result is robust to variations in the policy rule. It is also found that while financial leverage improves model fit when included in the policy rule, the response is pro-cyclical, which would unlikely be a feature of stabilization policy. Finally, there is no evidence that the policy interest rate responded to credit growth.

Energy price shocks, monetary policy and China's economic fluctuations

This paper develops a New Keynesian dynamic stochastic general equilibrium model with energy factors to study various channels through which China's economic fluctuations are linked to energy price shocks and to search for the optimal monetary policy to cope with energy price shocks. We conclude that there are channels through which changes in energy prices will have the following cause–effect relationships. First, a rise in energy price as a negative technology shock will raise the costs of providing capital services per unit of capital, thereby reducing output. Second, a rising energy price distorts the intertemporal choices of households and firms, creating downward pressure on the expected future return on capital. Third, an energy price shock places upward pressure on the marginal costs associated with an increase in inflation. Numerical simulation results show that a positive energy price shock has a positive effect on energy technology improvements. In addition, the effects of energy price shocks can be mitigated by nominal rigidities, and interest rate rules will determine the magnitude of those effects. Using the efficient frontier method, we also show that optimal monetary policy in China should help control energy price volatility.

Monetary policy and commodity terms of trade shocks in emerging market economies

Commodity terms of trade shocks have continued to drive macroeconomic fluctuations in most emerging market economies. The volatility and persistence of these shocks have posed great challenges for monetary policy. This study employs a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model to evaluate the optimal monetary policy responses to commodity terms of trade shocks in commodity dependent emerging market economies. The model is calibrated to the South African economy. The study shows that CPI inflation targeting performs relatively better than exchange rate targeting and non-traded inflation targeting both in terms of reducing macroeconomic volatility and reducing the losses of a non-benevolent central bank. However, macroeconomic stabilisation comes at a cost of increased exchange rate volatility. The results suggest that the appropriate response to commodity induced exogenous shocks is to target CPI inflation.

A Structural Investigation of the Chinese Economy with a Hybrid Monetary Policy Rule

In this paper, we aim to understand how monetary policy is conducted in China and what the main sources of fluctuations in China’s business cycle are. To this end, we extend a standard New Keynesian dynamic stochastic general equilibrium model with financial frictions and investment-specific technology shocks. We incorporate a hybrid form of monetary policy rule and employ a Bayesian estimation strategy using Chinese data. We find that the People’s Bank of China conducts monetary policy by adjusting the policy rate in response to inflation, output growth as well as real money growth. We also find that neutral technology shocks are the main drivers of the fluctuations in output and consumption while the investment-specific technology shock is the primary source of the variation in investment. This paper offers a new way of examining the rule of China’s monetary policy and indicates a structural break of the neutral technology development that may have caused the slowing down of GDP growth since 2010.