estimation solution and analysisestimation, solution and...
TRANSCRIPT
![Page 1: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/1.jpg)
Estimation Solution and AnalysisEstimation, Solution and Analysis of Equilibrium Monetary Models
Lawrence J. Christiano
![Page 2: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/2.jpg)
Questions• What role does monetary policy play in asset
market fluctuations? How should monetary policy react?p y
Japan's ‘Lost Decade’ of 1990s: Why?• Japan's Lost Decade of 1990s: Why?– Banking system?– Poor monetary policy?– Something else?
• How should monetary policy react to a financial crisis?
![Page 3: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/3.jpg)
W A Q i Lik Th• Ways to Answer Questions Like These:– Look at Historical Episodes (limited use)
E periment (not an option!)– Experiment (not an option!)– Experiment in Model Economies.
• Issues to Confront in Analysis of Model EconomiesEconomies– Empirical: Formulate and Estimate a Model– Analytic
• Appropriate Equilibrium Concepts for the Issue Studied• Relevant Computational Strategies• Other IssuesOther Issues.
![Page 4: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/4.jpg)
![Page 5: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/5.jpg)
Objectives• Provide Exposure to Key Aspects of
Formulation Estimation and Analysis ofFormulation, Estimation and Analysis of Equilibrium Models
• Provide Tutorials and MATLAB Software forProvide Tutorials and MATLAB Software for Analysis of a Range of Models, Which You May Find Useful as Templates for Future Research
• Target Audience:– People with Little Exposure to this Material– People Currently Already Actively Applying the
Material in their Research.
![Page 6: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/6.jpg)
Part I: Formulating and Estimating ModelsModels
• Vector Autoregressions (1.5 lectures)
– Identifying the Role of Shocks in Data• Monetary Policy Shocks• Technology ShocksTechnology Shocks• Fiscal Shocks
– What fraction of business fluctuations do these a ac o o bus ess uc ua o s do eseshocks account for?
– What is their dynamic effect on the economy?What is their dynamic effect on the economy?
– Assignments.
![Page 7: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/7.jpg)
Part I: Formulating and Estimating Models, cnt’d…Models, cnt d…
• Methods for Solving and Simulating DSGE Models (0.5 lectures)
– Three exercises:
• Exploring the ‘Hours Worked Hypothesis’ About Japanese Economic Slowdown in 1990s.
• ‘Overinvestment Boom’, An Interpretation of the 1990s ‘Bubble’
• Output Gap – what it is and how it relates to HP-filtered output
![Page 8: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/8.jpg)
Part I: Formulating and Estimating Models, cnt’d…Models, cnt d…
• Use of VARs to Estimate DSGE Models (1.5 lectures)
– Substantive Issue – apparent conflict between macro evidence of price inertia and micro evidence of volatilityvolatility
– Importance of various frictions
• Investment Adjustment Costs, Habit Persistence, Variable Capital Utilization
Th I t f Fi S ifi it f C it l• The Importance of Firm-Specificity of Capital
• Assignment: Can Replicate All Aspects of ACEL Analysis, and Explore Robustness.
• Bayesian Estimation
![Page 9: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/9.jpg)
Part II: Analysis of Models• Optimal Monetary and Fiscal Policy
– Basic Ramsey analysis in an economy without price-setting frictions– Lucas-Stokey cash-credit good model
S f h t h ith f i ti– Survey of what happens with frictions…
• Policy Rule Analysis:– Was the Surge of Inflation in the 1970s the Result of a Bad Taylor Rule?
• ‘Limited Participation Models’
– Can an ‘Escape Clause’ Help Correct Some of the Pathologies Associated with the Taylor Rule?
• Possible rationale for ECB ‘Twin Pillar’ policy.
– Should a Central Bank Raise or Lower the Interest Rate in the Wake of a Financial Crisis?• Small open economy model
– Could Monetary Policy be the Culprit Behind Stock-Market Boom-Bust Cycles?
– Could Rigid Adherence to a Low Inflation Target Cause an Economy to Fall Into A Liquidity Trap?
Cl i• Claim –– Low Inflation Target and Zero Lower Bound– Risk: Fall into a Downward Spiral of Deflation and Low Output
• Does Claim Hold Water In Reasonably Constructed Models of Economy?
![Page 10: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/10.jpg)
Vector AutoregressionsP d b Ch i Si i 1970 1980• Proposed by Chris Sims in 1970s, 1980s
• Major subsequent contributions by many others
• Useful Way to Organize Data– VARs serve as a ‘Battleground’ between alternative economic theories– VARs can be used to quantitatively construct a particular modelq y p
• Question that can (in principle) be addressed by VAR:– ‘How does the economy respond to a particular shock?’
A b f l– Answer can be very useful:• for discriminating between models• For estimating the parameters of a given model
• We will see, VARs can’t actually address such a question– Identification problem– Need extra assumptions….Structural VAR (SVAR).
![Page 11: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/11.jpg)
Outline of SVAR discussion• What is a VAR?
f• The Identification Problem
• Long run restrictions as a way to solve the problemLong run restrictions as a way to solve the problem– Bivariate Blanchard-Quah Example– The Multivariate Case
• Short Run Restrictions: Identification of Monetary Policy Shocks
• Results
• Historical Decompositions of Data
![Page 12: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/12.jpg)
![Page 13: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/13.jpg)
![Page 14: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/14.jpg)
![Page 15: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/15.jpg)
![Page 16: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/16.jpg)
![Page 17: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/17.jpg)
![Page 18: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/18.jpg)
![Page 19: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/19.jpg)
![Page 20: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/20.jpg)
![Page 21: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/21.jpg)
![Page 22: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/22.jpg)
![Page 23: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/23.jpg)
![Page 24: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/24.jpg)
![Page 25: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/25.jpg)
![Page 26: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/26.jpg)
![Page 27: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/27.jpg)
![Page 28: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/28.jpg)
![Page 29: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/29.jpg)
![Page 30: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/30.jpg)
![Page 31: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/31.jpg)
VAR estimation with the following data:
The data have been transformed to ensure stationaritySample period: 1959Q1-2001Q3
![Page 32: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/32.jpg)
![Page 33: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/33.jpg)
pI tends to be high in recessions
![Page 34: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/34.jpg)
Inflation a Little non-stationary
![Page 35: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/35.jpg)
S t fUS tradeBalanceissue
Sort ofstationary
![Page 36: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/36.jpg)
Note how high ratesTend to precede recessions
![Page 37: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/37.jpg)
Moves withInterestrate
![Page 38: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/38.jpg)
Shocks and Identification Assumptions
• Monetary Policy Shock
• Neutral Technology Shock
• Capital-Embodied Shock to TechnologyCapital Embodied Shock to Technology
Fi l P li Sh k• Fiscal Policy Shock
![Page 39: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/39.jpg)
Identifying Monetary Policy Shocks
• One strategy: estimate parameters of Fed’s gy pfeedback rule
– Rule that relates Fed’s actions to state of the economy.
Rt = f(Ωt) + etR
– f is a linear functionΩt: set of variables that Fed looks at.
– e R: time t policy shock– et : time t policy shock
![Page 40: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/40.jpg)
What does this rule represent?• Literal interpretation: structural policy rule of
central bankcentral bank.
• Combination of structural rule and other “stuff”• Combination of structural rule and other stuff
• Example: Clarida Gertler• Example: Clarida – Gertler– True policy rule
Rt EtX t1 etR
fall time t data used in E X eR fall time t data used in EtX t1 etR
![Page 41: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/41.jpg)
What is a Monetary Policy Shock?y y
• Shocks to preferences of monetary authorityp y y
• Strategic considerations can lead to exogenous g gvariation in policy
– Self-fulfilling expectation traps (Albanesi, Chari, Christiano)
• Technical factors like measurement error (Bernanke and Mihov)
![Page 42: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/42.jpg)
Recursiveness Assumption• Policy rule: Rt = f(Ωt) + et
R.
• Problem: not enough assumptions, yet, to identify etR
• Assume: – Policy shocks, et
R are orthogonal to Ωt.Ω contains current prices and wages aggregate quantities lagged stuffΩt contains current prices and wages, aggregate quantities, lagged stuff
• Economic content of this assumption:– Fed sees prices and output when it makes its choice of Rt.p p t– Prices and output don’t respond at time t to et
R.
• Assumption implies etR can be estimated by OLS
• Response of other variables can be obtained by regressing them on current and lagged et
R
![Page 43: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/43.jpg)
![Page 44: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/44.jpg)
![Page 45: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/45.jpg)
![Page 46: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/46.jpg)
• We will now estimate impulse responsesWe will now estimate impulse responses to a monetary policy shock using a VAR
• First, however, we have to talk about the t ti f t d dcomputation of standard errors
• We’ll discuss a standard bootstrap procedurep
![Page 47: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/47.jpg)
![Page 48: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/48.jpg)
![Page 49: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/49.jpg)
![Page 50: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/50.jpg)
Interesting Properties of Monetary Policy Shocks
• Plenty of endogenous persistence:
– money growth and interest rate over in 1 year, but other variables keep igoing….
• Significant liquidity effect
• Inflation slow to get off the ground: peaks in roughly two years– It has been conjectured that explaining this is a major challenge for
economicsChari Kehoe McGrattan (Econometrica) Mankiw– Chari-Kehoe-McGrattan (Econometrica), Mankiw.
– Kills models in which movements in P are key to monetary transmission mechanism (Lucas misperception model, pure sticky wage model)
• Output, consumption, investment, hours worked and capacity utilization hump-shaped
• Velocity comoves with the interest rate
![Page 51: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/51.jpg)
Timing Assumptions
• ‘Extreme’ Assumption:– Output Does Not Respond Instantly to Policy
Shock– Policy Responds Instantly to Output
• Could Make a Continuum of Alternative Assumptions: Is Our Choice Arbitrary?Assumptions: Is Our Choice Arbitrary?
Fact: Innovations in Output and Interest• Fact: Innovations in Output and Interest Rate are Positively Correlated
![Page 52: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/52.jpg)
![Page 53: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/53.jpg)
Timing Assumptions…• Identification Has to Come to Terms with Direction of Causation
Underlying Positive Correlation
• Does it Reflect:
1. Output Responding to Policy?2. Policy Responding to Output?3. Something in Between?
• We adopt interpretation (2)
• Choices (1) or (3) Imply:Choices (1) or (3) Imply:
– Monetary Policy Induced Rise in R Drives Output Up– Standard Monetary Models Inconsistent With This Implication
• Example: Presence of ambulances highly correlated with wounded people
– Interpretation #1: ambulances cause people to be hurtp p p– Interpretation #2: hurt people cause ambulances to come to them– Tough to go far with interpretation #1; prefer #2
![Page 54: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/54.jpg)
Result of Allowing Output to R d P liRespond to Policy
• A rise in R induced by policy, etR, produces aA rise in R induced by policy, et , produces a
rise in Y:
• Seems difficult to build a theory around this• Seems difficult to build a theory around this
![Page 55: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/55.jpg)
Neutral Technology Shocks Yt Z tFKt ,L t
• Technology shock is one of two shocks (we’ll see the other one later) that has a long run impact on the level of labor productivity aof labor productivity, at.
lim j→Et atj − E t−1atj f tz only
• This assumption makes it possible to identify dynamic• This assumption makes it possible to identify dynamic effects of a technology shock
• Identifying assumption satisfied by a large class of models.
![Page 56: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/56.jpg)
Technology Shocks…gy• Advantage of this approach:
– Don’t need to make all the usual assumptions required to construct Solow-residual based measures of technology shocks.
• Functional form assumptions for production function, corrections forFunctional form assumptions for production function, corrections for labor hoarding, capital utilization, and time-varying markups.
• Disadvantage: some models don’t satisfy our identifying g y y gassumption.
– endogenous growth models where all shocks affectendogenous growth models where all shocks affect productivity in the long run.
– Standard models when there are permanent shocksStandard models when there are permanent shocks to the tax rate on capital income.
![Page 57: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/57.jpg)
![Page 58: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/58.jpg)
Extension (Fisher JPE 2007)Extension (Fisher, JPE 2007)• There are two types of technology shocks: yp gy
neutral and capital embodiedXt ZtFKt , Lt
Kt1 1 − K t Vt It
• Both shocks can affect the long level of labor productivity and the growth rate of output
t1 t t t
productivity and the growth rate of output.• The only shock which affects the relative price of
capital is a capital embodied technology shockcapital is a capital embodied technology shock (Vt)
![Page 59: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/59.jpg)
![Page 60: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/60.jpg)
![Page 61: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/61.jpg)
![Page 62: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/62.jpg)
![Page 63: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/63.jpg)
![Page 64: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/64.jpg)
Historical Decomposition of Data i Sh kinto Shocks
• We can ask:We can ask:– What would have happened if only monetary
policy shocks had driven the data?policy shocks had driven the data?
– We can ask this about other identified shocks– We can ask this about other identified shocks, or about combinations of shocks
– We find that the three shocks together account for a large part of fluctuationsaccount for a large part of fluctuations
![Page 65: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/65.jpg)
Dark line: detrended actual GDP
Thin line: what GDP would have been if there had onlyThin line: what GDP would have been if there had only been one type of technology shock, the type thataffects only the capital goods industry
Th h k h ff t b t t t ibl i t tThese shocks have some effect, but not terribly important
![Page 66: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/66.jpg)
Type of technology shock that affectsType of technology shock that affectsall industries
This has very large impact on broad trends in thed t d ll i t b i ldata, and a smaller impact on business cycles.
Has big impact on trend in data, and 2000 boom-bust
![Page 67: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/67.jpg)
Monetary policy shocks have a big impact on 1980 ‘Volckerbig impact on 1980 Volcker recession’
![Page 68: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/68.jpg)
All three shocks together account for large part of business cycle
![Page 69: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/69.jpg)
![Page 70: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/70.jpg)
Fiscal Shocks• SVAR analysis of dynamic effects of fiscal
shocks useful for discriminating between models
– Neoclassical models suggest:• hours worked and aggregate output rise• real wages and consumption fall after an increase in gov’t
purchases.
M d l ith t li l k t th t– Models with countercyclical markups suggest that hours worked and output rise, and real wages rise (Rotemberg and Woodford).
– Blanchard and Perotti, (QJE, 2002), Gali, Lopez-Salido, Valles (2002), Ramey and Shapiro (1998, Carnegie Rochester) Burnside Eichenbaum andCarnegie-Rochester), Burnside, Eichenbaum and Fisher (1999)
![Page 71: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/71.jpg)
Fiscal ShocksFiscal Shocks…
• Key empirical issue: identifying exogenousKey empirical issue: identifying exogenous changes in fiscal policy.
• Hard to do standard VAR identification of fi l h kfiscal shocks
– In practice, people know that a fiscal shock is on the way, before it hits the data
![Page 72: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/72.jpg)
Burnside Eichenbaum and FisherBurnside, Eichenbaum and Fisher• Ramey and Shapiro identify three political events
th t l d t l ilit b ildthat led to large military buildups:
• Korean War -- 1950:3 Vietnam War -- 1965:1 Carter-ReaganKorean War -- 1950:3, Vietnam War -- 1965:1, Carter-Reagan build-up -- 1980:1
W k l th i d– Weakness: only three episodes.– Advantage: assumption that war episodes are
exogenous is compellingexogenous is compelling
• How does economy respond to these shocks?How does economy respond to these shocks?
![Page 73: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/73.jpg)
![Page 74: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/74.jpg)
• Evidence consistent with neoclassical model (real wage falls)
• When consumption is included, it turns out to rise, or remain unchanged.
• Problem: this contradicts neoclassical model.– Gali, Lopez-Salido, Valles have explored presence of
li idit t i dliquidity constrained consumers– May be consistent with Sims-Woodford fiscal theory
of the price levelof the price level
![Page 75: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/75.jpg)
Fiscal TheoryE ti d i ti t t t• Equation depicting payments to government bondholders:
B0 ∑ 1 tT G
• Standard Fiscal Theory
B0P0
∑t0 1
1rtTt − Gt
– Price level flexible– When G or T changes, P0 adjusts immediately
• Fiscal Theory with sticky prices– G jumps or T drops implies r falls
L i l i– Low r stimulates consumption
• To explore Fiscal Theory story, must check whatTo explore Fiscal Theory story, must check what happens to r after fiscal shock.
![Page 76: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/76.jpg)
• Fiscal policy shocksFiscal policy shocks– Example of Sims’ suggestion that VARs can
be a ‘battleground’ for discriminating betweenbe a battleground for discriminating between different theories.
![Page 77: Estimation Solution and AnalysisEstimation, Solution and ...faculty.wcas.northwestern.edu/~lchrist/course/lecture1.pdf · Estimation Solution and AnalysisEstimation, Solution and](https://reader030.vdocument.in/reader030/viewer/2022040823/5e6cef0787023520bd1429bf/html5/thumbnails/77.jpg)
Conclusions of VAR discussionConclusions of VAR discussion• We have reviewed identification of shocks with VARs.
• We identified three shocks which together account for a large fraction of output fluctuations.
• We also identified their dynamic effects on the economy.
• We discussed their usefulness in debates.
• Next:– Show how to estimate a model using impulse response functions– Before that, must study model solution methods.y