An Estimated DSGE Model of Energy, Costs and Inflation in the United Kingdom

Abstract

In this paper, I estimate a dynamic stochastic general equilibrium (DSGE) model of the United Kingdom. The basic building blocks of the model are standard in the literature. The main complication is that there are three consumption goods: non-energy output, petrol and utilities; given relative prices and their overall wealth, consumers choose how much of each of these goods to consume in order to maximize their utility. Each of the consumption goods is produced according to a sector - specific production function and sticky prices in each sector imply sector - specific New Keynesian Phillips Curves. I show how this model, once estimated, could form a useful additional input within a policymaker’s suite of models’ by considering its implications for the responses of various macroeconomic variables to different economic shocks and by decomposing recent movements of energy and non-energy output and inflation into the proportions caused by each of the shocks.

Keywords: dynamic stochastic general equilibrium model, energy prices and inflation

JEL Classification: E13, E31