An Open Economy Model for the Monetary Policy Analysis and Forecasting Jaromír Tonner, Jiří Polanský, Osvald Vašíček Department of Economics Faculty of Economics and Administration Masaryk University Oct. 22 - 23, 2010, Brno, Czech Republic. Outline o Introduction o Model o Model Estimation o Model Behaviour o Model Applications Conclusions r Tonner, J , Osvald N Conference in honour of Osvald ' 3 ^ O" Introduction o There are two antagonistic goals in modelling economic reality: to have a simple model in order to interpret its dynamics (SIMPLICITY), but there are always some observed facts we would like to incorporate (COMPREHENSIVENESS). o We are anywhere between.. o The objective of the talk is to simply explain our framework for forecasting and monetary policy analysis. r Tonner, J , Osvald N Conference in honour of Osvald ' 3 ^ O" Model - General Characteristics o The model follows some recent developments in construction dynamic models o Nominal frictions enrich the RBC dynamics o Structural model with forward looking rational expectations o Model is consistent with stock-flow national accounting o Model contains the balanced growth path concept (not a reduced-form gap model) o 11 sectors (households, 2 intermediate goods production sectors, 4 final goods production sectors, central monetary policy authority, central fiscal policy authority, forex dealers, rest of the world) GE SOE models for the Czech economy (tailor-made for the Czech economy) Inflation targeting regime - forward-looking monetary policy rule r Tonner, J , Osvald N Conference in honour of Osvald ' 5 ^ O" Model - Parameters The model is tailor-made for the Czech economy via o Parameters setting o Additional mechanisms as exogenous processes Time - variant parameters Expected time - variant parameters r Tonner, J , Osvald N Conference in honour of Osvald ' 3 ^ O" Model structure GDP Value Capital G = f(Y), Linear J, C, N Sticky In Home Prices Figure: Structure of the Model Added processes - households Regulated prices technology aRt Time-variant parameter netuler Time-varying parameters (a premium premt, Kforex, and „euler ) and an uncovered interest parity (UIP) shock £ uip t r Tonner, J , Osvald N Conference in honour of Osvald ' 3 •f)<\Q* Added processes - production o Export sector uses the intermediate import goods as one of its input Adjustment costs set to be zero for consumption, investment and export sectors o We modified the export sector (two inputs) r Tonner, J , Osvald N □ 9 Conference in honour of Osvald ' - 5 *r)<^o Added processes - policy We modified a monetary policy rule and added relating equations. The motivation here is to get the model closer to the official monetary policy rule of the CNB. We modified a fiscal policy rule. It is not straightforward to model fiscal policy properly in a representative-agents type monetary DSGE model since agents are optimizing on the infinite future. Our second reason is that it is much simpler to obtain an analytical steady state through the modified setting. r Tonner, J , Osvald N Conference in honour of Osvald ' 3 ^ O" Added processes - others Incorporation of the regulated prices technology to model a regulated prices sector. Incorporation of the export specific technology to incorporate Ballasha-Samuelson effect. Incorporation of the government specific technology to capture the government sector. Incorporation of the trade openness technology for the necessity of this technology for the Czech economy modelling. r Tonner, J , Osvald N Conference in honour of Osvald ' 3 ^ O" Model estimation Table: Estimated Parameters Parameter Prior Dist Post Interval Preferences Habits h 0.900 gamma 0.9409 ( 0.9326 0.9513 ) Labour supply coef. 8.832 gamma 8.8138 ( 8.7144 8.9094 ) Frisch elasticity 1.250 gamma 1.2556 ( 1.2330 1.2820 ) Wedges Euler Keuler 1.0119 - - Forex Kforex 1.0034 - - Adjustment costs Investment K 20.000 gamma 20.1364 ( 20.0852 20.2006 ) Capital utilization Y2 0.280 gamma 0.3229 ( 0.3054 0.3445 ) Risk premium 0.800 beta 0.8027 ( 0.7564 0.8553 ) Elasticities of substitution Domestic goods e 5.000 gamma 5.0035 ( 4.9562 5.0508 ) Import goods eM 9.000 gamma 9.0690 ( 9.0415 9.1017 ) Export goods ex 9.400 gamma 9.2646 ( 9.1852 9.3299 ) World goods eW 0.860 gamma 0.6938 ( 0.6090 0.7686 ) Consumption goods ec 7.600 gamma 7.6614 ( 7.6166 7.7022 ) Investment goods ei 7.600 gamma 7.5723 ( 7.5363 7.6029 ) Labour types V 7.000 gamma 7.0235 ( 7.0055 7.0428 ) □ - r Tonner , J , Osvald N Conference in honour of Osvald ' Model estimation Table: Estimated Parameters Parameter Prior Dist Post Interval Price and wage setting Calvo dom. prices 0.500 norm 0.6719 ( 0.6197 0.7600 ) Calvo exp. prices ox 0.080 gamma 0.2386 ( 0.1962 0.2814 ) Calvo imp. prices Om 0.750 norm 0.7309 ( 0.7046 0.7586 ) Calvo wages Ow 0.380 norm 0.4519 ( 0.4302 0.4744 ) Index. dom. prices x 0.750 gamma 0.7111 ( 0.6509 0.7688 ) Index. imp. prices XM 0.500 gamma 0.4519 ( 0.4187 0.4828 ) Index. exp. prices Xx 0.350 gamma 0.3600 ( 0.3157 0.4191 ) Index. wages Xw 0.920 gamma 0.9529 ( 0.9176 0.9859 ) Monetary policy Taylor rule (int. rates) 7R 0.960 gamma 0.9544 ( 0.9389 0.9716 ) Taylor rule (output gap) Yy 0.220 gamma 0.2233 ( 0.2109 0.2363 ) Taylor rule (inflation) 7n 1.150 gamma 1.1458 ( 1.1307 1.1600 ) Home bias Home bias in consump. nc 0.280 beta 0.3453 ( 0.2878 0.4080 ) Home bias in invest. ni 0.120 beta 0.3297 ( 0.2913 0.3608 ) Home bias in export nx 0.550 - - Growth rates Invest. spec. tech. AM 1.000 norm 1.0000 ( 0.9998 1.0002 ) General tech. AA 1.009 norm 1.0090 ( 1.0088 1.0092 ) Population AL 1.000 norm 1.0000 ( 0.9998 1.0001 ) ER appreciation ex 0.994 norm 0.9942 ( 0.9940 0.9944 ) Openness tech. aO 1.0035 - - Export spec. tech. ax 1.0058 - - □ < 1 ► < 1 3 •f)<\Q* r Tonner , J , Osvald N Conference in honour of Osvald ' Model estimation Table: Estimated Parameters Parameter AR coefs of shocks Intertemp. preferences. Hours preferences. Public consumption Foreign prices Foreign demand World interest rate Foreign debt Regulated prices General tech. Export specific tech. Wedge euler Wedge forex Standard devs of shocks Invest. spec. tech. General tech. Intertemp. preferences Hours preferences Monetary policy Foreign prices Foreign demand World interest rate Pd Pg Pvw pbW paR PA paX Pforex °a °A ° d ° p °m °nW °yw 0.550 0.400 0.750 0.300 0.750 0.825 0.450 0.300 0.750 0.200 0.500 0.600 0.045 0.010 0.250 0.001 0.008 0.010 0.310 0.003 beta 0.5370 ( 0.5163 , 0.5675 ) beta beta beta beta beta invg invg invg invg invg invg invg invg 0.7758 0.2992 0.7680 0.8365 0.4061 0.2048 0.0078 0.1831 0.0009 0.0033 0.0097 0.1681 0.0012 ( 0.7107 ( 0.2839 ( 0.7489 ( 0.8060 ( 0.3605 ( 0.1747 ( 0.0045 ( 0.1634 ( 0.0002 ( 0.0027 ( 0.0082 ( 0.1456 ( 0.0010 0.8488 ) 0.3161 ) 0.7884 ) 0.8600 ) 0.4439 ) 0.2324 ) 0.0110 ) 0.2087 ) 0.0015 ) 0.0038 ) 0.0112 ) 0.1883 ) 0.0014 ) r Tonner, J , Osvald Conference in honour of Osvald Prior Dist Post nterval Model estimation Table: Estimated Parameters Parameter Prior Dist Post Interval Premium gprem 0.400 invg 0.3140 ( 0.2454 , 0.3652 ) Openness »oO 0.095 invg 0.0609 ( 0.0448 , 0.0749 ) Regulated prices GaR 0.012 invg 0.0111 ( 0.0089 , 0.0133 ) Government specific »oG 0.038 invg 0.0269 ( 0.0199 , 0.0337 ) Population GL 0.0001 - - - Government g g 0.0001 - - - Export specific GaX 0.0001 - - - Target "target 0.0100 - - - UIP Guip 0.0001 - - - Wedge forex 0.0100 - - - Wedge euler "euler 0.0100 - - - Std of measurement errors Exchange rate gex 0.001 invg 0.0009 ( 0.0002 , 0.0016 ) Domestic interest rate gr 0.001 invg 0.0009 ( 0.0002 , 0.0016 ) Foreign interest rate gRW 0.001 invg 0.0008 ( 0.0002 , 0.0016 ) Domestic inflation gcpi 0.100 invg 0.0900 ( 0.0657,0.1128 ) Foreign inflation gpiw 0.100 invg 0.0643 ( 0.0295 , 0.1045 ) Import prices inflation gpm 2.000 invg 2.0983 ( 2.0442 , 2.1381 ) Export prices inflation gpx 3.000 invg 3.2641 ( 3.1952,3.3376 ) Investment prices inflation gpi 4.000 invg 4.0216 ( 3.9240 , 4.0849 ) Population gl 10.000 invg 9.3616 ( 9.3189 , 9.4103 ) Consumption gc 5.000 invg 5.3204 ( 5.2871 , 5.3603 ) Investment gi 4.000 invg 4.1811 ( 4.1423 , 4.2135 ) Export gx 10.000 invg 9.9154 ( 9.8412 , 9.9854 ) Import gm 10.000 invg 9.9734 ( 9.8564 , 10.0801 ) Foreign demand gyw 10.000 invg 10.0867 ( 10.0176 , 10.1802 ) Nominal wages gw 1.000 invg 0.8639 ( 0.8339 , 0.8987 ) Government spending_"G_5.000 invg 5.1637 ( 5.1101 , 5.2234 ) Model Behaviour Figure: Export specific technology shock Model Applications CPI Inflation (QoQ, ann.) ............ Interest Rate (%, ann.) Nominal Depreciation (QoQ, ann.) Nominal wages (QoQ, ann.) Figure: Filtration and Forecast a r Tonner, J , Osvald N Conference in honour of Osvald ' I/01 I/06 model data model data as ss -10 I/96 I/01 I/06 I/11 I/96 I/01 I/06 I/11 model data model data s ss Model Applications Model Applications Foreign demand (QoQ, ami.) Foreign interest Rate (%, ami.) Foreign prices (QoQ, ann.) Hours Worked (QoQ, ann.) Figure: Filtration and Forecast a r Tonner, J , Osvald Conference in honour of Osvald 2 0 -2 0 -8 0 1— I/96 I/01 I/06 I/01 I/06 I/11 model data model data ss as 15 10 I/96 I/01 I/06 I/11 I/96 I/01 I/06 model data model data ss s Model Applications Real Consumption (QoQ, ann.) Real Investment (QoQ, ann.) Real Export (QoQ, ann.) Real Import (QoQ, ann.) Figure: Filtration and Forecast a 3 •f)<\Q* r Tonner, J , Osvald N Conference in honour of Osvald 4 0 10 -4 0 -4 I/01 I/06 I/01 I/06 model data model data as ss 6 0 60 40 40 2 0 10 -2 0 10 -40 -3 0 I/96 I/01 I/06 I/11 I/96 I/01 I/06 I/11 model data model data s ss Model Applications Consumption deflator(QoQ, ann.) Investment deflator (QoQ, ann.) ............ \!\) 2 52 0 -15 -10 -5 ■ 0 i i -5 -10 [■ -15 I" -2 0^ Export deflator (QoQ, ann.) Import deflator (QoQ, ann.) Figure: Filtration and Forecast a r Tonner, J , Osvald N Conference in honour of Osvald ' 20 -30 1- I/96 I/01 I/06 model data model data as ss I/96 I/01 I/06 I/11 I/96 I/01 I/06 I/11 model data model data s ss Model Applications Figure: Filtration and Forecast Model Applications 2006:1_2007:1_2008:1_2009:1 2010:1 ] eps_A [ I eps_y_W [ 3 ^ O* 15 10 5 0 -5 -10 -15 -20 2005:1 REST eps mu Jaromfr Tonner , Jirf Polansky , Osvald Vasicek Model Applications Figure: Filtration and Forecast Model Applications theta p 0.6719 — -0.6719 - 0.7111 — - Figure: Filtration and Forecast a 3 •f)<\Q* r Tonner, J , Osvald N Conference in honour of Osvald ' J .6719 I/96 I/98 I/00 I/02 I/04 I/06 I/08 I/10 I/12 model as chi J.7111 0.711 I/96 I/98 I/00 I/02 I/04 I/06 I/08 I/10 I/12 model s Model Applications The first order approximation is yt = ys + Ayht-1 + But where ys is the steady state value of y and yht = yt - ys. The second order approximation is yt = ys + 0.5A2 + Ayht-l + But + 0.5C (yht-1 yht-i) + 0.5D(ut ut) + E(yht-1 ® ut) where ys is the steady state value of y, yht = yt - ys, and A2 is the shift effect of the variance of future shocks. r Tonner, J , Osvald N Conference in honour of Osvald ' 5 ^ O" Model Applications Model Applications 0.7 0.351-1-1-1-1-1-1 0 10 20 30 40 50 60 0.8 0.45'-'-'-'-'-'-' 0 10 20 30 40 50 60 Figure: Nonlinear Parameter Filtration Conclusions This work should bring following benefits: Qualitative improvements of understanding influences of especially monetary authority on economic environment. o A complex overview of existing methods and instruments for DSGE model identification with description of necessary advantages and disadvantages. o New challenges which occur when time - variant parameters are introduced. Closing Thank you for your attention Related papers of the authors are available on IS MUNI or: jtonner@tiscali.cz