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Working Paper
Bayesian estimation of DSGE models
We survey Bayesian methods for estimating dynamic stochastic general equilibrium (DSGE) models in this article. We focus on New Keynesian (NK)DSGE models because of the interest shown in this class of models by economists in academic and policy-making institutions. This interest stems from the ability of this class of DSGE model to transmit real, nominal, and fiscal and monetary policy shocks into endogenous fluctuations at business cycle frequencies. Intuition about these propagation mechanisms is developed by reviewing the structure of a canonical NKDSGE model. Estimation and evaluation of ...
Working Paper
Output dynamics in real business cycle models
The time series literature reports two stylized facts about output dynamics in the United States. GNP growth is positively autocorrelated over short horizons and negatively autocorrelated over longer horizons, and GNP has an important trend reverting component which has a hump-shaped moving average representation. We consider whether various real business cycle (RBC) models are consistent with these stylized facts. ; We find that many RBC models have weak internal propagation mechanisms and must rely on exogenous factors to replicate both stylized facts. In particular, intertemporal ...
Working Paper
Information criteria for impulse response function matching estimation of DSGE models
We propose a new information criterion for impulse response function matching estimators of the structural parameters of macroeconomic models. The main advantage of our procedure is that it allows the researcher to select the impulse responses that are most informative about the deep parameters, therefore reducing the bias and improving the efficiency of the estimates of the model?s parameters. We show that our method substantially changes key parameter estimates of representative dynamic stochastic general equilibrium models, thus reconciling their empirical results with the existing ...
Working Paper
Great moderations and U.S. interest rates: unconditional evidence
The Great Moderation refers to the fall in U.S. output growth volatility in the mid-1980s. At the same time, the United States experienced a moderation in inflation and lower average inflation. Using annual data since 1890, we find that an earlier, 1946 moderation in output and consumption growth was comparable to that of 1984. Using quarterly data since 1947, we also isolate the 1969?83 Great Inflation to refine the asset pricing implications of the moderations. Asset pricing theory predicts that moderations?real or nominal?influence interest rates. We examine the quantitative predictions of ...
Working Paper
Exchange rates and fundamentals: a generalization
Exchange rates have raised the ire of economists for more than twenty years. The problem is that few, if any, exchange rate models are known to systematically beat a naive random walk in out-of-sample forecasts. Engel and West (2005) show that these failures can be explained by the standard present value model (PVM) because it predicts random walk exchange rate dynamics if the discount factor approaches one and fundamentals have a unit root. This paper generalizes the Engel and West hypothesis to the larger class of open economy dynamic stochastic general equilibrium (DSGE) models. The Engel ...
Working Paper
Common trends and common cycles in Canada: who knew so much has been going on?
It is generally accepted that convergence is well established for regional Canadian per capita outputs. The authors present evidence that long-run movements are driven by two stochastic common trends in this time series. This evidence casts doubt on the convergence hypothesis for Canada. Another prevalent belief is that Canada forms an optimal currency area (OCA). The authors uncover three serially correlated common cycles whose asymmetries suggest Canada is not an OCA. Their common trend-common cycle decomposition of regional outputs also reveals that trend shocks dominate fluctuations in ...
Working Paper
Simple versus optimal rules as guides to policy
This paper contributes to the policy evaluation literature by developing new strategies to study alternative policy rules. We compare optimal rules to simple rules within canonical monetary policy models. In our context, an optimal rule represents the solution to an intertemporal optimization problem in which a loss function for the policymaker and an explicit model of the macroeconomy are specified. We define a simple rule to be a summary of the intuition policymakers and economists have about how a central bank should react to aggregate disturbances. The policy rules are evaluated under ...
Working Paper
The McKenna rule and U.K. World War I finance
The United Kingdom employed the McKenna rule to conduct fiscal policy during World War I (WWI) and the interwar period. Named for Reginald McKenna, Chancellor of the Exchequer (1915?16), the McKenna rule committed the United Kingdom to a path of debt retirement, which we show was forward-looking and smoothed in response to shocks to the real economy and tax rates. The McKenna rule was in the tradition of the ?English method? of war finance because the United Kingdom taxed capital to finance WWI. Higher rates of capital taxation also paid for debt retirement during and subsequent to WWI. The ...
Working Paper
The present-value model of the current account has been rejected: Round up the usual suspects
Tests of the present-value model of the current account are frequently rejected by the data. Standard explanations rely on the "usual suspects" of nonseparable preferences, shocks to fiscal policy and the world real interest rate, and imperfect international capital mobility. The authors confirm these rejections on postwar Canadian data, then investigate their source by calibrating and simulating alternative versions of a small open economy, real business cycle model. Monte Carlo experiments reveal that, although each of the suspects matters in some way, a "canonical" RBC model moves ...
Working Paper
Investment and the current account in the short run and the long run
Theoretical models of the relationship between investment and the current account impose restrictions on the joint dynamic behavior of these variables. These restrictions come in two forms. One imposes causal orderings on investment and the current account. The other restriction concerns the permanent responses of these variables to different shocks. We use these restrictions to identify empirically structural shocks from vector autoregressions of investment and the current account for Canada. Under certain identifications, our results support the implications of the intertemporal, small open ...