Testing for Indeterminacy: An Application to U. S. Monetary Policy

46 Pages Posted: 12 Aug 2002

See all articles by Thomas A. Lubik

Thomas A. Lubik

Johns Hopkins University - Department of Economics

Frank Schorfheide

University of Pennsylvania - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: July 2002

Abstract

This paper considers a prototypical monetary business cycle model for the U.S. economy, in which the equilibrium is undetermined if monetary policy is "inactive". In previous multivariate studies it has been common practice to restrict parameter estimates to values for which the equilibrium is unique. We show how the likelihood-based estimation of dynamic stochastic general equilibrium models can be extended to allow for indeterminacies and sunspot fluctuations. We propose a posterior odds test for the hypothesis that the data are best explained by parameters that imply determinacy. Our empirical results show that the Volcker-Greenspan policy regime is consistent with determinacy, whereas the pre-Volcker regime is not. We find that before 1979 non-fundamental sunspot shocks may have contributed significantly to inflation and interest rate volatility, but essentially did not affect output fluctuations.

Keywords: Econometric Evaluation and Testing, Rational Expectations Models, Indeterminacy, Monetary

JEL Classification: C11, C52, C62, E52

Suggested Citation

Lubik, Thomas A. and Schorfheide, Frank, Testing for Indeterminacy: An Application to U. S. Monetary Policy (July 2002). PIER Working Paper No. 02-025. Available at SSRN: https://ssrn.com/abstract=322224 or http://dx.doi.org/10.2139/ssrn.322224

Thomas A. Lubik

Johns Hopkins University - Department of Economics ( email )

3400 Charles Street
Baltimore, MD 21218-2685
United States

Frank Schorfheide (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

HOME PAGE: http://www.econ.upenn.edu/~schorf

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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