• Parameter Bias in an Estimated DSGE Model: Does Nonlinearity Matter?
  Takeki SunakawaYasuo Hirose

  Abstract

  How can parameter estimates be biased in a dynamic stochastic general equilibrium model that omits nonlinearity in the economy? To answer this question, we simulate data from a fully nonlinear New Keynesian model with the zero lower bound constraint and estimate a linearized version of the model. Monte Carlo experiments show that significant biases are detected in the estimates of monetary policy parameters and the steady-state inflation and real interest rates. These biases arise mainly from neglecting the zero lower bound constraint rather than linearizing equilibrium conditions. With fixed parameters, the variance-covariance matrix and impulse response functions of observed variables implied by the linearized model substantially differ from those implied by its nonlinear counterpart. However, we find that the biased estimates of parameters in the estimated linear model can make most of the differences small.

  Introduction

  Following the development of Bayesian estimation and evaluation techniques, many economists have estimated dynamic stochastic general equilibrium (DSGE) models using macroeconomic time series. In particular, estimated New Keynesian models, which feature nominal rigidities and monetary policy rules, have been extensively used by policy institutions such as central banks. Most of the estimated DSGE models are linearized around a steady state because a linear state-space representation along with the assumption of normality of exogenous shocks enables us to efficiently evaluate likelihood using the Kalman filter. However, Fern´andez-Villaverde and Rubio-Ram´ırez (2005) and Fern´andez-Villaverde, Rubio-Ram´ırez, and Santos (2006) demonstrate that the level of likelihood and parameter estimates based on a linearized model can be significantly different from those based on its original nonlinear model. Moreover, in the context of New Keynesian models, Basu and Bundick (2012), Braun, K¨orber, and Waki (2012), Fern´andez-Villaverde, Gordon, Guerr´on-Quintana, and Rubio-Ram´ırez (2015), Gavin, Keen, Richter, and Throckmorton (2015), Gust, L´opez-Salido, and Smith (2012), Nakata (2013a, 2013b), and Ngo (2014) emphasize the importance of considering nonlinearity in assessing the quantitative implications of the models when the zero lower bound (ZLB) constraint on the nominal interest rate is taken into account.

  2016.03

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• An Estimated DSGE Model with a Deflation Steady State
  Yasuo Hirose

  Abstract

  Benhabib, Schmitt-GrohÈ, and Uribe (2001) argue for the existence of a deflation steady state when the zero lower bound on the nominal interest rate is considered in a Taylor-type monetary policy rule. This paper estimates a medium-scale DSGE model with a deflation steady state for the Japanese economy during the period from 1999 to 2013, when the Bank of Japan conducted a zero interest rate policy and the inflation rate was almost always negative. Although the model exhibits equilibrium indeterminacy around the deflation steady state, a set of specific equilibria is selected by Bayesian methods. According to the estimated model, shocks to householdsí preferences, investment adjustment costs, and external demand do not necessarily have an inflationary effect, in contrast to a standard model with a targeted-inflation steady state. An economy in the deflation equilibrium could experience unexpected volatility because of sunspot fluctuations, but it turns out that the effect of sunspot shocks on Japanís business cycles is marginal and that macroeconomic stability during the period was a result of good luck.

  Introduction

  Dynamic stochastic general equilibrium (DSGE) models have become a popular tool in macroeconomics. In particular, following the development of Bayesian estimation and evaluation techniques, an increased number of researchers have estimated DSGE models for empirical research as well as quantitative policy analysis. These models typically consist of optimizing behavior of households and firms, and a monetary policy rule, along the lines of King (2000) and Woodford (2003). In this class of models, a central bank follows an active monetary policy rule; that is, the nominal interest rate is adjusted more than one for one when inflation deviates from a given target, and the economy fluctuates around the steady state where actual inflation coincides with the targeted inflation. In addition to such a target-inflation steady state, Benhabib, Schmitt-GrohÈ, and Uribe (2001) argue that the combination of an active monetary policy rule and the zero lower bound on the nominal interest rate gives rise to another long-run equilibrium, called a deflation steady state, where the inflation rate is negative and the nominal interest rate is very close to zero.

  2014.08

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• Zero Lower Bound and Parameter Bias in an Estimated DSGE Model
  Atsushi InoueYasuo Hirose

  Abstract

  This paper examines how and to what extent parameter estimates can be biased in a dynamic stochastic general equilibrium (DSGE) model that omits the zero lower bound constraint on the nominal interest rate. Our experiments show that most of the parameter estimates in a standard sticky-price DSGE model are not biased although some biases are detected in the estimates of the monetary policy parameters and the steady-state real interest rate. Nevertheless, in our baseline experiment, these biases are so small that the estimated impulse response functions are quite similar to the true impulse response functions. However, as the probability of hitting the zero lower bound increases, the biases in the parameter estimates become larger and can therefore lead to substantial differences between the estimated and true impulse responses.

  Introduction

  Dynamic stochastic general equilibrium (DSGE) models have become a prominent tool for policy analysis. In particular, following the development of Bayesian estimation and evaluation techniques, estimated DSGE models have been extensively used by a range of policy institutions, including central banks. At the same time, the zero lower bound constraint on the nominal interest rates has been a primary concern for policymakers. Much work has been devoted to understand how the economy works and how policy should be conducted in the presence of this constraint from a theoretical perspective. However, empirical studies that estimate DSGE models including the interest-rate lower bound are still scarce because of computational difficulties in the treatment of nonlinearity arising from the bound, and hence most practitioners continue to estimate linearized DSGE models without explicitly considering the lower bound.

  2013.09

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