The federal reserve board MPS quarterly econometric model of the US economy

This paper describes the structure and properties of the Federal Reserve Board's (MPS) econometric model of the US economy. The theoretical underpinnings are developed using a small growth model that is a simplified version of the steady-state structure of the full model. Short-run dynamic properties, which are Keynesian, are discussed and quantified with simulation results. The largest part of the paper consists of a discussion of the theoretical basis and empirical properties of the key behavioural equations. A complete list of equations is included.     

Modelling trigonometric seasonal components for monthly economic time series

The basic structural time series model has been designed for the modelling and forecasting of seasonal economic time series. In this article, we explore a generalization of the basic structural time series model in which the time-varying trigonometric terms associated with different seasonal frequencies have different variances for their disturbances. The contribution of the article is two-fold. The first aim is to investigate the dynamic properties of this frequency-specific Basic Structural Model (BSM). The second aim is to relate the model to a comparable generalized version of the Airline model developed at the US Census Bureau. By adopting a quadratic distance metric based on the restricted reduced form moving-average representation of the models, we conclude that the generalized models have properties that are close to each other compared to their default counterparts. In some settings, the distance between the models is almost zero so that the models can be regarded as observationally equivalent. An extensive empirical study on disaggregated monthly shipment and foreign trade series illustrates the improvements of the frequency-specific extension and investigates the relations between the two classes of models.     

A test for the presence of central bank intervention in the foreign exchange market with an application to the Bank of Canada

In this article, a general nonlinear simultaneous equations framework for the econometric analysis of models of intervention in foreign exchange markets by central banks in response to deviations of exchange rates from target levels is proposed. The instrumental variables estimation of possibly nonlinear response functions and tests of intervention, when the functional form may be nonlinear, asymmetric, and may contain unknown shape parameters, is considered. The methodology applies techniques developed for testing in the presence of nuisance parameters unidentified under a null hypothesis to a nonlinear simultaneous equations model. The results of an empirical analysis of stabilization activity of the Bank of Canada, for the period from 1953 to 2009, with regard to the Canada–U.S exchange rate are reported here. A nonlinear specification is found necessary to capture activity after 1998.     

Cost structure,technological change,and productivity growth in the greek banking sector

This paper first empirically investigates the cost structure of the Greek banking sector. Secondly, it provides measures of economies (diseconomies) of scale and quantifies technical change and its sources. Finally, this paper measures total factor productivity growth and identifies its sources. Bank production is presented with two different approaches (the intermediation and the production approach) which are used to specify a translog cost function. The two different translog cost models are estimated through the full information maximum likelihood method of estimation on pooled time series and cross sectional data. The results obtained are not significantly affected by model specification. Both models indicate significant economies of scale and negative annual rates of growth in technical change and in total factor productivity.     

The P* model and Austrian prices

In theP ^* model the price level is determined by the money stock per unit of potential out-put and the long-run equilibrium level of the velocity of money. This article applies this model to Austria. Problems in identifying permanent shocks to potential output and/or velocity lead to the rejection of such models of the price level, but their first-difference version is not so suspect. While evidence is found of a long-run relationship between Austria inflation and money growth, even the first-difference version of theP ^* model is rejected for Austria. Since Austria is a small economy, closely tied to Germany, the article also investigates whether Austrian prices are tied to a GermanP ^* measure. This hypothesis is also rejected, but there is a statistically-significant long-run relationship between Austrian and German inflation. Moreover, Austrian money growth remains significant even in this relationship.This article was written while the author was a Visiting Scholar at the Austrian National Bank. The author is indebted to Fritz Breuss, W. Jahnke, and Dieter Proske for help in obtaining the data used here, and for useful discussions about the data, relevant theoretical issues and results. The comments of the referees on an earlier version are also gratefully acknowledged. The views expressed here are those of the author and are not necessarily those of the Austrian National Bank, the Federal Reserve Bank of St. Louis, or the Board of Governors of the Federal Reserve System.     

Putting the present value model into practice: a comparison of two alternative approaches

A key issue around putting the present-value model into practice is how to construct the unobserved future expectations of the fundamental variables related to an asset. One approach is to fit a vector autoregression (VAR) for the fundamental variables and deduce their future expectations from the estimated VAR. An alternative is to directly specify the future expectations as unobserved components (UC) and use the Kalman filter to extract their estimates from the realized data. This article examines whether the predictions of the present-value model are consistent across the two approaches. Constructing the VAR and UC versions of the standard present-value model, we examine how the two versions compare in identifying the main driver of the US and UK housing markets. For the UK, the two approaches consistently attribute most variations in the price–rent ratio to the expected future risk premium for housing investment. For the US, however, the two approaches deliver considerably different results: the VAR version marks the expected risk-free rate of return, whereas the UC version singles out the expected risk premium as the main driver of the ratio. We conclude that the choice between the VAR and UC approaches is not a trivial issue related to utilizing the present-value model.     

Cross-border acquisitions: the UK experience

This paper tests a composite empirical model of cross-border acquisitions involving UK firms between 1987–1995 using panel data analysis. The empirical model includes capital market variables and regulatory variables derived from the existing literature. The results show that models that explain cross-border acquisitions through capital market imperfections are not significant. Cross-border activity has a strong relationship with the level of the UK stock market suggesting that crossborder acquisitions are, in some part, an extension of domestic activity. Corporate tax differentials also have significant impact on activity.     

Is there a natural level of capacity utilization?

Previous studies of the Phillips Curve using capacity, utilization have estimated NAIRCU to be in the neighborhood of 82%. These studies estimate NAIRCU by imposing the restriction that there is no stable long run relationship between capacity utilization and the rate of inflation. The authors of these studies test the validity of this restricted model by estimating a model of the Phillips Curve, which has no supply-side variables. However, the actual estimates of NAIRCU are derived from restricted models, which include supply side variables. This article replicates these findings and then tests the validity of the restriction using a correctly specified model. An important finding is that the restriction is not valid and therefore the models used to produce estimates of NAIRCU are misspecified. Our findings call into question the existence of a vertical long run Phillips Curve. The implications of our findings are that the FED was overly cautious in raising interest rates to slow the economy and that the policy of pursuing “full employment” is still viable. I would like to thank James Swaney, Paulette Olson and Thomas Traynor for their helpful comments and numerous suggestion on an earlier version of this paper. Any errors that remain are the sole responsibility of the author.     

Does the monetary policy committee still care about inflation? Some evidence from a small macroeconomic model

This article derives an optimal Taylor rule for the UK economy using a simple estimated model based on data prior to the financial crisis of 2008. Optimal policy rules are calculated using simulation of the model over a long time period coupled with a search for optimal Taylor rule parameters using the Newton-Raphson loss minimization algorithm. The weights in the pre-crisis loss function are then inferred from the Taylor rule parameters estimated from the period corresponding to Bank of England independence, i.e. 1997–2008. These estimates are consistent with a low weight on inflation relative to output stabilization even before the crisis. The model is therefore consistent with the hypothesis that there has been no change in Bank of England preferences and that the Bank has responded to the crisis in a way which would have been predicted on the basis of its pre-crisis behaviour.     

The choice of a foreign price measure in a Bayesian estimated new-Keynesian model for Israel

We estimate a small DSGE model by full information Bayesian techniques on the basis of Israeli data from 1995 to 2006. The model was first developed and estimated by means of classical GMM in Argov and Elkayam (2010), and since then it has been used at the Bank of Israel for monetary policy analysis. It is widely believed that in 2007 (out of sample year) as elsewhere worldwide, inflation rose in Israel due to high commodity prices in global markets. However, our baseline model attributes most of the high inflation in 2007 to supply shocks. One conjecture is that this model's result derives from the inappropriate original use of the unit value of imported consumer goods (which do not include unprocessed food and energy) as the main foreign price measure. We test this conjecture by re-estimating the model with various other foreign price measures that typically do reflect the global rise in commodity prices and compare the log-marginal likelihoods. We find that no other price measure outperforms the original choice in the sample period. Only the foreign trade-weighted CPI equals the performance of the original choice while improving the 2007 interpretation of inflation, and should therefore be considered the main foreign price measure. The proposed methodology for comparing the suitability of alternative measures for observable variables can be applied to any model with exogenous variables that are characterized by univariate equations.     

An empirical study of outbound tourism demand in the UK

A general to specific methodology is used to construct UK demand for outbound tourism models to twelve destinations. A tourism destination preference index is introduced to take into account social, cultural and psychological influences on tourists' decisions concerning their overseas holiday destinations. The tests support the existence of a cointegration relationship for each of 11 UK overseas holiday destinations. The corresponding error correction models are estimated. The empirical results show that the long-run income elasticities for all destinations range from 1.70 to 3.90 with an average of 2.367. The lowest and highest short-run income elasticities are 1.05 and 3.78 respectively, with an average of 2.216. The estimates of the income elasticities imply that overseas holidays are highly income elastic while the own-price elasticities suggest that the demand for UK outbound tourism is relatively own-price inelastic. In terms of the significance of substitution prices in the regression equations, Ireland is the favourite substitute destination for UK outbound tourists. Ex post forecasts over a period of six years are generated from the ECM models and the results compared with those of a naive model, an AR(1) model, an ARMA(p,q) model, and a VAR model. The forecasting performance criteria show that the ECM model has the best overall forecasting performance for UK outbound tourism.     

The importance of the distinction between long- and short-term unemployment in UK macroeconometric models

This paper examines the degree of support for distinct duration effects on wages across a variety of wage equations, and investigates their importance in full simulations with three large-scale UK macroeconometric models. The paper begins by highlighting deficiencies both in the way that existing models determine the duration structure of unemployment and in the specification of long-term unemployment in the wage equation. By constructing a single preferred wage equation we test hypotheses relating to duration effects and, although tests are not conclusive, find some support for the use of short-term unemployment in the wage equation. However, it is also shown that the response of wages to changes in unemployment is similar regardless of whether aggregate or short-term unemployment is used in the wage equation, although this does not hold when the duration structure of unemployment changes radically. By substituting revised equations into the models we show that these results carry over to full model simulations. Thus although neglect of duration effects may not be crucial in assessing the effectiveness of standard macro policy instruments, this is not likely to be true when evaluating policies which are deliberately targeted at the long-term unemployed.     

Equilibrium-correction vs. differencing in macroeconometric forecasting

Recent work by Clements and Hendry elucidate why forecasting systems that are in terms of differences, dVARs, can be more accurate than econometric models that include levels variables, EqCMs. For example, dVAR forecasts are in some cases insulated from parameter non-constancies in the long run mean of the cointegration relationships. In this paper, the practical relevance of these issues are investigated for RIMINI, the quarterly macroeconometric model used in Norges Bank (Central Bank of Norway), an example of an EqCM forecasting model. We develop two dVAR versions of the full RIMINI model and compare EqCM and dVAR forecasts for the period 1992.1–1994.4. We also include forecasts from univariate dVAR type models. The results seem to confirm the relevance of the theoretical results. First, dVAR forecasts appear to provide some immunity against parameter non-constancies that could seriously bias the EqCM forecasts. Second, the misspecification resulting from omitting levels information generates substantial biases in the dVAR forecasts 8 and 12 quarters ahead.     

Modelling the business cycle of a small open economy: The Reserve Bank of New Zealand's DSGE model

We describe the underlying structure of the new forecast and policy model used at the Reserve Bank of New Zealand and evaluate its ability to explain New Zealand data. Unlike other estimated small-open-economy DSGE models, we find that more than one third of the domestic GDP growth is driven by foreign shocks. The elevated contribution of foreign shocks to the domestic economy is driven by our decision to exclude mapping export demand to data on world GDP. Estimating our model without any foreign demand data limits the response of exports to the real exchange variations. This feature makes exports and, consequently, domestic GDP much more sensitive to variations to foreign demand and raises the importance of foreign shocks to the domestic business cycle. Furthermore, our analysis suggests that a model with “adaptive” expectations is preferred by the data relative to the version of the model with “rational” expectations. In that case, the model explains nominal variables using on average much smaller shocks.     

Pricing-to-market tests in instrumental regressions: Case of the transportation equipment industry

Pricing-to-market (PTM) theory suggests that exporting monopolistic firms adjust their destination-specific mark-ups in the face of exchange rate shocks. A large proportion of the existing evidence for PTM comes from Wald tests applied to OLS- and IV-estimated parameters of single-equation models. Such tests can seriously over-reject in the presence of endogeneity and weak instruments so that some of the available results supporting PTM could be spurious. In this paper we revisit the PTM evidence for Japanese and German exporting firms in the transportation equipment industry. Using the model of Marston (1990), we apply exogeneity and LR-LIML-based tests for which the error probability is controlled irrespective of the quality of the available instruments. Our results show right-hand-side endogeneity in almost all of the examined PTM equations. In addition, we find that statistical decisions often differ depending on whether they are based on the traditional Wald test or on our proposed test.The authors would like to thank Philippe Barla, Jean-Thomas Bernard, Christos Constantatos, Larry Schembri, seminar participants at the Bank of Canada, and two anonymous referees for useful comments and suggestions. Thanks also to Richard Marston for providing data. Finally, a special thanks to Marjorie Santos for excellent research assistance. All remaining errors are our own and should not be attributed to the Bank of Canada.First version received: May 2002/Final version received: December 2002     

The Southampton econometric model

Four reasons are offered for presenting a paper on a now defunct model. First it was one of the very few attempts to construct a large-scale econometric model of the UK. Second, is its monetary sector — few models of that vintage had such a sector and, unlike modern models, its monetary sector was strictly Keynesian. Third is the explicit modelling of output and price equations. And fourth is the treatment of disequilibrium. Disequilibrium arises through the incompatibility of plans: total demand, for example, may exceed total supply and profits may be exceptionally high or unsustainably low. The rest of the paper gives a fuller account of the role of these disequilibrium terms in the explanation of price and output changes. Lists of equations and working papers are attached.     

A simultaneous disequilibrium model for Italian export goods

An econometric methodology is proposed for simultaneously estimating a disequilibrium macroeconomic model which takes into account the interactions occurring between variables or equations when aggregate quantities come from markets which do not clear. A specification of disequilibrium is considered which is substantially a simultaneous version of the well known partial adjustment model, instead of taking into account the conventional “short-side” rule. A simple model for italian manufactured export goods is estimated with limited and full information techniques subject to cross equation restrictions which permit the identification of the structural parameters of the model. By investigating the extent to which these restrictions are supported by evidence, this approach is shown to be useful for the comprehension of how the italian export market for manufactured goods operates. Tests on equilibrium versus disequilibrium hypothesis seem to support such a specification for macro-disequilibrium.     

Instrumental variables and wavelet decompositions

The application of wavelet analysis provides an orthogonal decomposition of a time series by time scale, thereby facilitating the decomposition of a data series into the sum of a structural component and a random error component. The structural components revealed by the wavelet analysis yield nearly ideal instrumental variables for variables observed with error and for co-endogenous variables in simultaneous equation models. Wavelets also provide an efficient way to explore the path of the structural component of the series to be analyzed and can be used to detect some specification errors. The methodology described in this paper is applied to the errors in variables problem and simultaneous equations case using some simulation exercises and to the analysis of a version of the Phillips curve with interesting results.