Supply, Demand and Monetary Policy Shocks in a Multi-Country New Keynesian Model

55 Pages Posted: 17 Sep 2010

See all articles by Stephane Dees

Stephane Dees

European Central Bank (ECB)

M. Hashem Pesaran

University of Southern California - Department of Economics; University of Cambridge - Trinity College (Cambridge)

L. Vanessa Smith

University of York - Department of Economics and Related Studies

Ron Smith

Birkbeck College

Multiple version iconThere are 2 versions of this paper

Date Written: August 23, 2010

Abstract

This paper estimates and solves a multi-country version of the standard DSGE New Keynesian (NK) model. The country-specific models include a Phillips curve determining inflation, an IS curve determining output, a Taylor Rule determining interest rates, and a real effective exchange rate equation. The IS equation includes a real exchange rate variable and a country-specific foreign output variable to capture direct inter-country linkages. In accord with the theory all variables are measured as deviations from their steady states, which are estimated as long-horizon forecasts from a reduced-form cointegrating global vector autoregression. The resulting rational expectations model is then estimated for 33 countries on data for 1980Q1-2006Q4, by inequality constrained IV, using lagged and contemporaneous foreign variables as instruments, subject to the restrictions implied by the NK theory. The multi-country DSGE NK model is then solved to provide estimates of identified supply, demand and monetary policy shocks. Following the literature, we assume that the within country supply, demand and monetary policy shocks are orthogonal, though shocks of the same type (e.g. supply shocks in different countries) can be correlated. We discuss estimation of impulse response functions and variance decompositions in such large systems, and present estimates allowing for both direct channels of international transmission through regression coefficients and indirect channels through error spillover effects. Bootstrapped error bands are also provided for the cross country responses of a shock to the US monetary policy.

Keywords: Global VAR (GVAR), New Keynesian DSGE models, supply shocks, demand shocks, monetary policy shocks

JEL Classification: C32, E17, F37, F42

Suggested Citation

Dees, Stephane and Pesaran, M. Hashem and Smith, L. Vanessa and Smith, Ron P., Supply, Demand and Monetary Policy Shocks in a Multi-Country New Keynesian Model (August 23, 2010). ECB Working Paper No. 1239, Available at SSRN: https://ssrn.com/abstract=1663882

Stephane Dees (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

M. Hashem Pesaran

University of Southern California - Department of Economics

3620 South Vermont Ave. Kaprielian (KAP) Hall 300
Los Angeles, CA 90089
United States

University of Cambridge - Trinity College (Cambridge) ( email )

United Kingdom

L. Vanessa Smith

University of York - Department of Economics and Related Studies ( email )

Heslington
University of York
York, YO10 5DD
United Kingdom

Ron P. Smith

Birkbeck College ( email )

Malet Street
London WC1E 7HX
United Kingdom
+44 207 631 6413 (Phone)
+44 207 631 6416 (Fax)

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