Academic journal article Federal Reserve Bank of St. Louis Review

Editor's Introduction

Academic journal article Federal Reserve Bank of St. Louis Review

Editor's Introduction

Article excerpt

Recent advances in monetary policy research involve general equilibrium modeling. There is often a long lag between the time new ideas gain acceptance in academic circles and the time when they are integrated into the policymaking process. One purpose of our annual conferences is to shorten that lag by supporting research aimed directly at issues policymakers care about. For instance, in this conference we look at practical implications of recent research in general equilibrium modeling. Three of the six papers focus on the long-term bond market. Bond markets often play the role of "canary in the mineshaft," providing early warning about shifts in expectations of monetary policy. The longer-term interest rates are also seen as more important for aggregate demand, especially for investment. Because the Fed operates with a target for the interest rate on overnight lending in the market for federal funds, it is natural for us to want to know more about how monetary policy affects the term structure of interest rates and how expectations about monetary policy are revealed in market pricing.

The Thirty-First Annual Policy Conference of the Federal Reserve Bank of St. Louis brought together economists working at the frontier in monetary policy research, bringing new ideas that have come from research in general equilibrium modeling. Participants at the conference highlighted both the promise and the limitations of recent advances.

A POLICY MODEL FOR THE U.K. ECONOMY

In the first paper presented at the conference, Riccardo DiCecio and Edward Nelson presented a monetary policy model estimated to fit U.K. data. The model is a dynamic stochastic general equilibrium (DSGE) model based on the popular work of Christiano, Eichenbaum, and Evans (2005; CEE). This version of the DSGE model is characterized by a number of economic frictions arising from wage and price contracts, wage and price indexation to the previous period's inflation rate, habit formation in consumption, investment adjustment costs, variable capital utilization, and an assumption that firms must pay their wage bill with funds borrowed in the previous period. This is a New Keynesian (NK) version of the DSGE model, named for the exogenous price and/or wages frictions that are imposed.

The identification of macroeconometric models has always been a problem because of the large number of parameters relative to the short spans of time over which we can credibly assume that economic structure has been stationary. Of course, having a new policy model for the United Kingdom is important in its own right, but it is also important to investigate the mapping of models into reality using all the data available.

The U.K. data offer an interesting challenge to the authors. The advantage of the U.K. experience is that they have had many policy changes--changes that induce a reaction that help the econometrician identity the effects of policy. On the other hand, the numerous changes in monetary and fiscal policies make it difficult to model a general policy rule that spans the available history. Indeed, the authors find that they cannot estimate a stable policy function if they include the full data set from 1962 through 2005. Instead, they present several sets of results based on different observation periods.

In general, the authors report preference and production parameter estimates for the United Kingdom that are consistent with those estimated by CEE for the United States; however, there is less evidence for the United Kingdom that variable capacity utilization matters. The most important finding for the United Kingdom that differs sharply from CEE's finding for the United States is that it is price stickiness and not wage stickiness that is the most important in the monetary transmission mechanism.

In their comments on the paper, Martin Fukac and Adrian Pagan discussed important issues involving the econometric methods used by the authors (and CEE) and made specific recommendations for future research. …

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