Monetary Transmission Channels in DSGE Models: Decomposition of Impulse Response Functions Approach
- 279 Downloads
The paper presents decomposition of impulse response functions (IRFs) as a new diagnostic tool for dynamic stochastic general equilibrium (DSGE) models. This method works with any DSGE model of arbitrary complexity or theoretical background. It is also applicable to any policy transmission channels. We illustrate it with monetary transmission mechanisms in two New Keynesian general equilibrium models: QUEST_III model of the European Commission and Smets–Wouters model of the USA economy. For that purpose, we use DYNARE platform for solving the models and provide a MATLAB file for IRFs decomposition. The underlying software can handle decomposition of IRFs using both the first-order and the second-order approximation of Taylor series to equilibrium relations. An IRF aggregates partial contributions of all state variables to impulse responses of a model’s variable to a stochastic shock. The IRF decomposition identifies individual contributions of state variables and marks each particular channel that a policy shock uses to propagate throughout the model. We show in two illustrated cases that monetary transmission channels might be quite distinct even if DSGE models employ the same (Taylor) policy rule and reveal similar IRFs. More specifically, IRFs initiated by a monetary shock might misrepresent the pure interest rate impact on some variables. Decomposition of monetary IRFs casts more light on flexibility needed in an economy to contain negative impact of a monetary shock.
KeywordsImpulse response functions QUEST III model Smets–Wouters model Monetary policy Rigidities DYNARE
We thank to Marco Ratto for useful comments and research guidance. Of course, we are responsible for computation and findings.
- Adjemian, S., Bastani, H., Karame, F., Juillard, M., Maih, J., & Mihoubi, F., et al. (2011). DYNARE: Reference manual, version 4. DYNARE working papers, CEPREMAP. http://www.dynare.org.
- Blanchard, O. J., & Kahn, C. M. (1980). The solution of linear difference models under rational expectations. Econometrica, 48(5), 1305–1311.Google Scholar
- Collard, F., & Juillard, M. (2001). Accuracy of stochastic perturbation methods: The case of asset pricing models. Journal of Economic Dynamics & Control, 25. http://pages.stern.nyu.edu/~dbackus/GE_asset_pricing/computation/CollardJuillardstochperturbationJEDC01.pdf.
- Hamilton, J. D. (1994). Time series analysis. Princeton University Press. doi: 10.2307/1270781.
- Judd, K. L. (1998). Numerical methods in economics. MIT Press. https://mitpress.mit.edu/books/numerical-methods-economics.
- Judd, K. L., & Jin, H.-H. (2002). Perturbation methods for general dynamic stochastic models. Working paper, pp. 1–44. http://web.stanford.edu/~judd/papers/PerturbationMethodRatEx.pdf.
- King, R. G., Plosser, C. I., & Rebelo, S. T. (1988). Production, growth and business cycles. Journal of Monetary Economics, 21, 195–232.Google Scholar
- Ljungqvist, L., & Sargent, T. J. (2000). Recursive macroeconomic theory (2nd ed.). Cambridge: MIT Press.Google Scholar
- McCandless, G. (2008). The ABCs of RBCs: An introduction to dynamic macroeconomic models. Harvard University Press. http://www.amazon.com/dp/0674028147.
- Ratto, M., Roeger, W., & in’t Veld, J. (2009). QUEST III: An estimated DSGE model of the euro area with fiscal and monetary policy. Economic Modelling, 26. doi: 10.2765/86277.
- Rotemberg, J. J., & Woodford, M. (1997). An optimization-based framework for the evaluation. In NBER macroeconomics annual 1997 (Vol. 12, pp. 297–361). http://www.nber.org/chapters/c11041.
- Sims, C. (2002). Solving linear rational expectations models. Computational Economics, 20(1–2), 1–21. http://sims.princeton.edu/yftp/gensys/.
- Stokey, N. L., Lucas, R. E. J., & Prescott, E. C. (1989). Recursive methods in economic dynamics. Cambridge: Harvard University Press.Google Scholar
- Uhlig, H. (2001). A toolkit for analysing nonlinear dynamic stochastic models easily. In R. Marimon & A. Scott (Eds.), Computational methods for the study of dynamic economies, (Chap 3). Oxford University Press. doi: 10.1093/0199248273.003.0003.
- Woodford, M. (2003). Interest and prices: Foundations of a theory of monetary policy. Princeton University Press. http://press.princeton.edu/titles/7603.html.