Habit Formation, Price Indexation and Wage Indexation in the DSGE Model: Specification, Estimation and Model Fit

Open access

Habit Formation, Price Indexation and Wage Indexation in the DSGE Model: Specification, Estimation and Model Fit

In order to determine which specification provides better fit of the data, this paper presents several specifications of a closed economy DSGE model with nominal rigidities. The goal of this paper is to find out whether some characteristics widely used in New Keynesian DSGE models, such as habit formation in consumption, price indexation and wage indexation, provide better fit of the macroeconomic data. Model specifications are estimated on the data of the US economy and Euro Area 12 economy, using Bayesian techniques, particularly the Metropolis-Hastings algorithm (using Dynare toolbox for Matlab). The data fit measure is a Bayes factor calculated from marginal likelihoods, acquired from Bayesian estimation. Results suggest that including habit formation in consumption significantly improves the empirical data fit of the model, whereas including partial price indexation and partial wage indexation does not improve the empirical data fit of the model. Variants with full price indexation and full wage indexation were the worst ones concerning their data fit.

CALVO, G. (1983). Staggered Prices in a Utility Maximizing Framework. Journal of Monetary Economics. 12(3), pp. 383-398.

CHRISTIANO, L. J., EICHENBAUM, M., EVANS, C. L. (2005). Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy. Journal of Political Economy. 113(1), pp. 1-45. DOI: 10.1086/426038

ČAPER, J. (2010). Comparing the fit of New Keynesian DSGE models. Ekonomická revue - Central European Review of Economic Issues. 13(4), pp. 207-218.

DeJONG, D. N., DAVE, C. (2007). Structural Macroeconometrics. New Jersey: Princeton University Press.

FUHRER, J. C. (2000). Habit Formation in Consumption and Its Implications for Monetary-Policy Models. American Economic Review. 90(3), pp. 367-390.

GALÍ, J. (2008). Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework. New Jersey: Princeton University Press.

GALÍ, J., GERTLER, M., LOPEZ-SALIDO, D. J. (2005). Robustness of the Estimates of the Hybrid New Keynesian Phillips Curve. Journal of Monetary Economics. 52(6), pp. 1107-1118. DOI:10.1016/j.jmoneco.2005.08.005

GALÍ, J., GERTLER, M. (1999). Inflation Dynamics: A Structural Economic Analysis. CEPR Discussion Papers 2246.

JEFFREYS, H. (1961). Theory of Probability. Oxford: Oxford University Press.

JUSTINIANO, A., PRESTON, B. (2004). Small Open Economy DSGE models: Specification, Estimation and Model Fit. Working paper, Department of Economics, Columbia University.

JUSTINIANO, A., PRESTON, B. (2010). Can Structural Small Open Economy Models Account for the Influence of Foreign Disturbances? Journal of International Economics. 81(1), pp. 61-74. DOI:10.1016/j.jinteco.2010.01.001

KASS, R. E., RAFTERY, A. E. (1995). Bayes Factors. Journal of the American Statistical Association. 90(430), pp. 773-795.

LIU, P. (2006). A Small New Keynesian Model of the New Zealand Economy. Reserve Bank of New Zealand, Discussion Paper Series DP 2006/03.

MATHESON, T. D. (2010). Assessing the Fit of Small Open Economy DSGEs. Journal of Macroeconomics. 32(3), pp. 906-920. DOI: 10.1016/j.jmacro.2009.10.001

MUSIL, K., VAŠÍČEK, O. (2006). Behavior of the Czech Economy: New Open Economy Macroeconomics DSGE Model. CVKS MU, Working paper No. 23/2006.

NAKAMURA, E., STEINSSON, J. (2008). Five Facts about Prices: A Reevaluation of Menu Costs Models. The Quarterly Journal of Economics. 123(4), pp. 1415-1464. DOI: 10.1162/qjec.2008.123.4.1415

RABANAL, P., RUBIO-RAMIREZ, J. (2005). Comparing New Keynesian Models of the Business Bycle: A Bayesian Approach. Journal of Monetary Economics. 52(6), pp. 1151-1166. DOI:10.1016/j.jmoneco.2005.08.008

REMO, A. (2008). Monetary Policy and Stability of Czech Economy: Optimal Commitment Policy in NOEM DSGE Framework. CVKS MU, Working paper No. 25/2008.

SLANICAY, M., VAŠÍČEK, O. (2009). Porovnání různých specifikací novokeynesiánského DSGE modelu malé otevřené ekonomiky pro ČR." In Slaný (ed.): Ekonomické prostředí a konkurenceschopnost (pp. 203-216). Brno: CVKS MU.

SMETS, F., Wouters, R. (2003). An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area. Journal of the European Economic Association. 1(5), pp. 1123-1175.

TAYLOR, J. B. (1999a). Staggered Price and Wage Setting in Macroeconomics. In Taylor and Woodford (eds.), Handbook of Macroeconomics (chap. 15, 1341-1397). New York: Elsevier.

TAYLOR, J. B. (1999b). A Historical Analysis of Monetary Policy Rules. In Taylor (ed.), Monetary Policy Rules. Chicago: University of Chicago Press.

WOODFORD, M. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. New Jersey: Princeton University Press.

Review of Economic Perspectives

Národohospodárský obzor; The Journal of Masaryk University

Journal Information


CiteScore 2017: 0.42

SCImago Journal Rank (SJR) 2017: 0.153
Source Normalized Impact per Paper (SNIP) 2017: 0.351

Metrics

All Time Past Year Past 30 Days
Abstract Views 0 0 0
Full Text Views 222 221 14
PDF Downloads 55 55 4