A Matter of Perspective: Mapping Linear Rational Expectations Models into Finite-Order VAR Form

Globalization Institute Working Paper 389

21 Pages Posted: 30 Jun 2020

See all articles by Enrique Martínez-García

Enrique Martínez-García

Federal Reserve Bank of Dallas - Research Department

Date Written: May 10, 2020

Abstract

This paper considers the characterization of the reduced-form solution of a large class of linear rational expectations models. I show that under certain conditions, if a solution exists and is unique, it can be cast in finite-order VAR form. I also investigate the conditions for the VAR form to be stationary with a well-defined residual variance-covariance matrix in equilibrium, for the shocks to be recoverable, and for local identification of the structural parameters for estimation from the sample likelihood. An application to the workhorse New Keynesian model with accompanying Matlab codes illustrates the practical use of the finite-order VAR representation. In particular, I argue that the identification of monetary policy shocks based on structural VARs can be more closely aligned with theory using the finite-order VAR form of the model solution characterized in this paper.

Keywords: Linear Rational Expectations Models, Finite-Order Vector Autoregressive Representation, Sylvester Matrix Equation, New Keynesian Model, Monetary Policy Shocks

JEL Classification: C32, C62, C63, E37

Suggested Citation

Martinez-Garcia, Enrique, A Matter of Perspective: Mapping Linear Rational Expectations Models into Finite-Order VAR Form (May 10, 2020). Globalization Institute Working Paper 389 , Available at SSRN: https://ssrn.com/abstract=3620368 or http://dx.doi.org/10.2139/ssrn.3620368

Enrique Martinez-Garcia (Contact Author)

Federal Reserve Bank of Dallas - Research Department ( email )

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Dallas, TX 75265-5906
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214-922-5262 (Phone)

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