New Keynesian Dynamic Stochastic General Equilibrium Model Research Articles

DYNAMICS OF OPTIMUM MONETARY POLICY IN A SMALL OPEN-ECONOMY: A NEW-KEYNESIAN DSGE MODEL FOR TURKISH ECONOMY

The purpose of this paper is to investigate the sources of business cycle fluctuations in a small open economy (SOE) using dynamic stochastic general equilibrium (DSGE) models and to assess the path of optimal policy decisions taken by the Central Bank of the Republic of Turkey (CBRT). To that purpose, the SOE-DSGE model is estimated using the Bayesian technique with Turkish data spanning the quarters 2003Q2–2020Q1. Based on the estimated model, the study finds that the explanatory power of the SOE-DSGE model for household, firm and central bank behavior decreases when consumer habit formation, price indexation and exchange rate sensitivity are included. Furthermore, technology, preferences, and risk premium shocks all have a significant impact on the Turkish economy. The CBRT, on the other hand, was principally concerned with price stabilization, interest rate smoothing, output and output growth stabilization, and nominal exchange rate stabilization, respectively. More importantly, the optimal monetary policy function implies that output growth should be better stabilized if exchange rate sensitivity target is ignored.

Incentive effect of structural tax reduction policy on consumption upgrading and high-tech industry

China is implementing a structural tax reduction policy to upgrade the structure of household consumption and promote the development of high-tech industry. This article constructs a heterogeneous NK-DSGE (New Keynesian - Dynamic Stochastic General Equilibrium) model to study the effects of tax reduction policies on consumption upgrading and the development of high-tech industry. The tax categories involved in this model are divided into demand-side tax and supply-side tax. We build two indexes to measure the consumption structure and the development of high-tech industry. It is found that reducing high-tech enterprise income tax would upgrade the consumption structure and promote the development of high-tech industries in the short term. Reducing low-tech enterprise income tax would achieve similar effects in the medium and long term. Moreover, tax such as consumption tax, labour income tax and capital income tax reduction policies can upgrade the consumption structure and promote the development of high-tech industry in the long term. Finally, this article finds that when the elasticity of labour substitution is smaller, reducing high-tech enterprise income tax is more effective.

The rebuilding macroeconomic theory project part II: multiple equilibria, toy models, and policy models in a new macroeconomic paradigm

AbstractThis issue of the Oxford Review of Economic Policy is the second in the Rebuilding Macroeconomic Theory project. The papers in the first issue proposed specific improvements to the New-Keynesian Dynamic Stochastic General Equilibrium (NK-DSGE) framework, in response to the events of the 2008 crisis. This issue goes further. We, as editors, now argue that a new multiple-equilibrium and diverse (MEADE) paradigm is needed for macroeconomics. It will emphasize that economies can have more than one stable outcome, and study why. It will require using both toy models, which enable a quick, first-pass, intuitive understanding of a question, and policy models (aka structural economic models) which develop a detailed empirical understanding of the economy. We argue that the seminal IS/LM, Solow–Swan, Ramsey, Real Business Cycle, Taylor, and Clarida/Galí/Gertler models have all been toys, as is the benchmark NK-DSGE model. In the past the models have adapted as the questions changed, and the NK-DSGE model must now do this since it has failed to capture both the salient aspects of the lead-up to the 2008 crisis and the slow recovery afterwards. The way forward in the MEADE paradigm will be to start with simple models, ideally two-dimensional sketches, that explain mechanisms that can cause multiple equilibria. These mechanisms should then be incorporated into larger DSGE models in a new, multiple-equilibrium synthesis. All of this will need to be informed by closer fidelity to the data, drawing on lessons obtained from detailed work on policy models.

Personal Income Tax Reform, Income Inequality and Social Welfare

In 2018, China’s personal income tax system ushered in the seventh reform after its introduction in 1980. In this reform, tax exemption and tax rate table are still the main adjustment objects. However, there are still a lot of debates on the actual distribution effect of such reform measures.The specific research objects of this paper can be divided into the following two issues: (1) Can the common measures of personal income tax reform in China since 2005 bring a positive income distribution effect? (2) While adjusting income distribution, can the reform of personal income tax bring a positive welfare effect in the process of economic fluctuation? The research on the above two issues is not only conducive to improving the fairness of distribution, but also helpful to explore the new orientation of future personal income tax reform and realize the reasonable coordination between fairness and efficiency, which makes the research content more suitable for the reform and development needs of stable employment and stable growth under the new normal state of China’s economy.In the process of research, this paper first constructs a new Keynesian dynamic stochastic general equilibrium (NK-DSGE) model with heterogeneous households and progressive personal income tax, and realizes the parameterization of the model with the usage of Bayesian estimation method. Then, using the NK-DSGE model, the dynamic simulation (impulse response analysis) of the effect of the personal income tax reform plan in 2018 (and the possible extensive plan in the future) is carried out. Finally, the welfare loss function is derived from the NK-DSGE model equations, and the efficiency decline and welfare loss caused by various personal income tax reform measures are calculated. Compared with the existing literature, the NK-DSGE analysis in this paper is not only limited to depicting the progressivity of tax rate (the progressive range of tax rate in the tax rate table), but also can simulate the effect of diversified personal income tax reform measures including tax exemption, and analyze the superposition and interaction of different reform measures based on flexible model construction and simulation analysis scheme design.The results show that: (1) The increase of tax exemption expands the fluctuation of pre-tax income inequality and worsens the initial distribution under exogenous shocks such as loose monetary policy. Moreover, the increase of tax exemption weakens the adjustment ability of progressive tax rate to the primary distribution of income. (2) In the process of employment expansion, the change of tax burden brought about by the increase of tax exemption improves the after-tax income distribution. Moreover, after the increase of tax exemption, the increase of the progressivity of tax rate can further improve the income redistribution. Of course, the primary distribution effect and redistribution effect of personal income tax reform have the characteristics of state dependence, which will bring an opposite distribution effect when employment and labor income decrease. (3) Increasing the amount of tax exemption will lead to greater welfare loss, and at the same time, it will weaken the inhibitory effect of progressive tax rate on welfare loss.The main policy enlightenment from the above research results is that future personal income tax reform should carefully adjust tax exemption and focus on the increase of the progressivity of tax rate, so as to better guarantee the high-quality development of China’s economy. In addition, we can also consider adding the dynamic rules of tax exemption which peg the aggregate fluctuation of employment and income to deal with the state dependence of the distribution effect of exemption adjustment policy, so as to make the adjustment of tax exemption produce continuous and positive distribution effects.

South Africa’s monetary policy independence: evidence from a Global New-Keynesian DSGE model

ABSTRACTWe study the response of South African monetary policy decisions to foreign monetary policy shocks. We estimate the extent of foreign monetary policy pass through by augmenting standard Taylor rules and comparing the results within the context of a Global New-Keynesian Dynamic Stochastic General Equilibrium (DSGE) model. The general equilibrium model captures important spill-over effects that would otherwise have been ignored in a single equation set-up. The results show that the relationship between foreign monetary policy shocks and South African interest rates is complicated – South Africa does not import foreign monetary policy directly, but is still affected. Except for the US, an increase in foreign interest rates leads to a decrease in South African interest rates – highlighting the complex channels that the monetary policy authority has to monitor outside of its economy.

On the choice of monetary policy rules for China: A Bayesian DSGE approach

Motivated by the institutional features of China's monetary policy, this paper aims at identifying the most data favored monetary policy rule for China within a dynamic stochastic general equilibrium (DSGE) model framework. In a canonical New-Keynesian DSGE model, we carry out a positive analysis by employing Bayesian methods to estimate three main categories of monetary policy rules, namely a Taylor-type interest rate rule, a money growth rule and an expanded Taylor rule with money. Based on China's quarterly data from 1996Q2 to 2015Q4, our estimation shows that the expanded Taylor rule obtains the best empirical fit to the data. Moreover, impulse responses and forecast error variance decompositions demonstrate that monetary policy rules with or without money provide very different implications for the policy behavior. Our results ultimately suggest that money has so far been more closely targeted than nominal interest rate and still plays an important role as a monetary policy target in China. Furthermore, a conventional Taylor-type interest rate rule is not good enough yet to describe China's monetary policy behavior.

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.

Business Cycle Implications of Internal Consumption Habit for New Keynesian Models

We study the implications of internal consumption habit for New Keynesian dynamic stochastic general equilibrium (NKDSGE) models. Bayesian Monte Carlo methods are employed to evaluate NKDSGE model fit. Simulation experiments show that internal consumption habit often improves the ability of NKDSGE models to match the spectra of output and consumption growth. Nonetheless, the fit of NKDSGE models with internal consumption habit is susceptible to the sources of nominal rigidity, to spectra identified by permanent productivity shocks, to the choice of monetary policy rule, and to the frequencies used for evaluation. These vulnerabilities indicate that the specification of NKDSGE models is fragile.

Business Cycle Implications of Internal Consumption Habit for New Keynesian Models

This paper studies the implications of internal consumption habit for new Keynesian dynamic stochastic general equilibrium (NKDSGE) models. Bayesian Monte Carlo methods are employed to evaluate NKDSGE model fit. Simulation experiments show that consumption habit often improves the ability of NKDSGE models to match output and consumption growth spectra. Nonetheless, the fit of NKDSGE models with consumption habit is susceptible to the source of the nominal rigidity, to spectra identified by permanent productivity shocks, to the frequencies used for evaluation, and to the choice of monetary policy rule. These vulnerabilities suggest that NKDSGE model specification is fragile.

A New‐Keynesian DSGE model for forecasting the South African economy

AbstractThis paper develops a New‐Keynesian Dynamic Stochastic General Equilibrium (NKDSGE) model for forecasting the growth rate of output, inflation, and the nominal short‐term interest rate (91 days Treasury Bill rate) for the South African economy. The model is estimated via maximum likelihood technique for quarterly data over the period of 1970:1–2000:4. Based on a recursive estimation using the Kalman filter algorithm, out‐of‐sample forecasts from the NKDSGE model are compared with forecasts generated from the classical and Bayesian variants of vector autoregression (VAR) models for the period 2001:1–2006:4. The results indicate that in terms of out‐of‐sample forecasting, the NKDSGE model outperforms both the classical and Bayesian VARs for inflation, but not for output growth and nominal short‐term interest rate. However, differences in RMSEs are not significant across the models. Copyright © 2008 John Wiley & Sons, Ltd.