Estimating Intertemporal Elasticity of Substitution in a Sticky Price Model
30 Pages Posted: 10 Jul 2013
Date Written: May 27, 2013
Cancellation of income and substitution effect implied by King-Plosser-Rebelo (1988) preferences breaks tight coefficient restriction between the slope of the Phillips curve and the elasticity of consumption with respect to real interest rate in a sticky price macro model. This facilitates the estimation of intertemporal elasticity of substitution using full information Bayesian Maximum Likelihood techniques within a structural model. The US data from the period 1984–2007 supports low intertemporal elasticity of substitution and strongly rejects a logarithmic and an additively separable utility specification commonly applied in the New Keynesian literature.
Keywords: monetary policy, Bayesian estimation, non-separable utility
JEL Classification: E32, E52, E21
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