SVERIGES RIKSBANK

OCCASIONAL PAPER SERIES 12

Ramses II - Model Description

Malin Adolfson, Stefan Lasen, Lawrence Christiano, Mathias Trabandt and Karl Walentin

February 2013

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Ramses II - Model Description

Malin Adolfsona Stefan Lasena

Lawrence Christianob, Mathias Trabandtc, Karl Walentina

a Sveriges Riksbankb Northwestern Universityc Federal Reserve Board

February 2013

Abstract

This paper describes Ramses II, the dynamic stochastic general equilibrium (DSGE) modelcurrently in use at the Monetary Policy Department of Sveriges Riksbank. The model is usedto produce macroeconomic forecasts, alternative scenarios, and for monetary policy analysis.The model was initially developed by Christiano, Trabandt and Walentin (2011). This paperdescribes the version of the model used for policy and diers in some respects from Christiano,Trabandt and Walentin. Compared with the earlier DSGE model at Sveriges Riksbank, theRamses model developed by Adolfson et. al. (2008), Ramses II diers in three importantrespects: i) nancial frictions are introduced in the accumulation of capital following Bernanke,Gertler and Gilchrist (1999), ii) the labor market block includes search and matching followingMortensen and Pissarides (1994), and iii) imports are allowed to enter export production aswell as in the aggregate consumption and investment baskets.

Keywords: DSGE, nancial frictions, labor market frictions, unemployment, small open econ-omy, Bayesian estimation.JEL codes: E0, E3, F0, F4, G0, G1, J6.

The model description draws heavily on Christiano, Trabandt, and Walentin (2011).The views expressed in this paper are solely the responsibility of the authors and should not be interpreted as reect-ing the views of the Executive Board of Sveriges Riksbank or those of the Board of Governors of the Federal ReserveSystem or of any other person associated with the Federal Reserve System. We are grateful to Ulf Sderstrm forcomments and suggestions.Corresponding author: Stefan Lasen, Sveriges Riksbank, Monetary Policy Department, SE-103 37 Stockholm, Swe-den. e-mail : stefan.laseen@riksbank.se.

Contents

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 Ramses II: A Small Open Economy Model . . . . . . . . . . . . . . . . . . . . . . . . . . . 42.1 Intermediate input goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

2.1.1 Production of the Domestic Homogeneous Good . . . . . . . . . . . . . . . . 52.1.2 Production of Imported Intermediate Goods . . . . . . . . . . . . . . . . . . . 7

2.2 Production of Final Consumption Goods . . . . . . . . . . . . . . . . . . . . . . . . . 92.3 Production of Final Investment Goods . . . . . . . . . . . . . . . . . . . . . . . . . . 102.4 Production of Final Export Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102.5 Households . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

2.5.1 Household Consumption Decision . . . . . . . . . . . . . . . . . . . . . . . . . 132.5.2 Financial Assets and Interest Rate Parity . . . . . . . . . . . . . . . . . . . . 13

2.6 Capital Accumulation and Financial Frictions . . . . . . . . . . . . . . . . . . . . . . 152.6.1 Capital Accumulation and Investment Decision . . . . . . . . . . . . . . . . . 172.6.2 The Individual Entrepreneur . . . . . . . . . . . . . . . . . . . . . . . . . . . 172.6.3 Aggregation Across Entrepreneurs and the External Financing Premium . . . 21

2.7 Wage Setting and Employment Frictions . . . . . . . . . . . . . . . . . . . . . . . . . 222.7.1 Labor Hours . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 242.7.2 Vacancies and the Employment Agency Problem . . . . . . . . . . . . . . . . 262.7.3 Worker Value Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282.7.4 Bargaining Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

2.8 Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302.9 Fiscal Authorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302.10 Foreign Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312.11 Resource Constraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

2.11.1 Resource Constraint for Domestic Homogeneous Output . . . . . . . . . . . . 322.11.2 Trade Balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

2.12 Exogenous Shock Processes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333 Estimation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343.1 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 343.2 Calibration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 353.3 Choice of priors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 373.4 Shocks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 383.5 Measurement errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 393.6 Measurement equations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

4 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 414.1 Posterior parameter values . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 414.2 Model t . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 424.3 Smoothed shock processes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434.4 Impulse response functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 444.5 Variance Decomposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 454.6 Forecasts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 464.7 Level data on unemployment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47A Tables and Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53B Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65B.1 Scaling of Variables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

2

B.2 Functional forms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66B.3 Baseline Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

B.3.1 First order conditions for domestic homogenous good price setting . . . . . . 67B.3.2 First order conditions for export good price setting . . . . . . . . . . . . . . . 69B.3.3 Demand for domestic inputs in export production . . . . . . . . . . . . . . . 70B.3.4 Demand for Imported Inputs in Export Production . . . . . . . . . . . . . . . 71B.3.5 First order conditions for import good price setting . . . . . . . . . . . . . . 71B.3.6 Household Consumption and Investment Decisions . . . . . . . . . . . . . . . 71B.3.7 Wage setting conditions in the baseline model . . . . . . . . . . . . . . . . . . 73B.3.8 Output and aggregate factors of production . . . . . . . . . . . . . . . . . . . 79B.3.9 Restrictions across ination rates . . . . . . . . . . . . . . . . . . . . . . . . . 81B.3.10 Endogenous Variables of the Baseline Model . . . . . . . . . . . . . . . . . . . 81

B.4 Equilibrium Conditions for the Financial Frictions Model . . . . . . . . . . . . . . . 82B.4.1 Derivation of Aggregation Across Entrepreneurs . . . . . . . . . . . . . . . . 82B.4.2 Equilibrium Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

B.5 Equilibrium Conditions from the Employment Frictions Model . . . . . . . . . . . . 84B.5.1 Labor Hours . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84B.5.2 Vacancies and the Employment Agency Problem . . . . . . . . . . . . . . . . 84B.5.3 Agency Separation Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . 88B.5.4 Bargaining Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95B.5.5 Final equilibrium conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97B.5.6 Characterization of the Bargaining Set . . . . . . . . . . . . . . . . . . . . . . 98

B.6 Summary of equilibrium conditions for Employment Frictions in the Baseline Model 99B.7 Summary of equilibrium conditions of the Full Model . . . . . . . . . . . . . . . . . . 100

3

1. Introduction

This paper describes Ramses II, the dynamic stochastic general equilibrium (DSGE) model cur-

rently in use at the Monetary Policy Department of Sveriges Riksbank. The model is used to pro-

duce macroeconomic forecasts, to construct alternative scenari