Testing the encompassing implications

So far the NPCM has mainly been used to describe the inflationary process in studies concerning the United States economy or for aggregated Euro data. Heuristically, we can augment the basic model with import price growth and other open economy features, and test the significance of the forward infla­tion rate within such an extended NPCM. Recently, Batini et al. (2000) have derived an open economy NPCM from first principles, and estimated the model on United Kingdom economy data. Once we consider the NPCM for individual European economies, there are new possibilities for testing—since pre-existing results should, in principle, be explained by the new model (the NPCM)...

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Productivity at

Productivity growth Д^ is basically modelled as a moving average with declining weights

Дat = 0.73 — 0.76Д^_ 1 — 0.79Д^_ 2 — 0.48Да^ 3 (0.15) (0.05) (0.05) (0.10)

— 0.18ecmat — 0.06Adumt + 0.08Seasonalt_ 3 (9.10)

(0.04) (0.02) (0.01)

T = 1972(4)-2001(1) = 114

a = 1.52%

Far(i-S)(5, 102) = 0.17[0.97]

X2normality(2) = 1.23[0.54]

FHETx2 (10,96) = 0.74[0.69].

(Reference: see Table 9.2. The numbers in [..] are p-values.)

In the longer run the development is influenced by the real wage, by unem­ployment and by technical progress—proxied by a linear trend—as expressed by the equilibrium correction mechanism

ecmat = at-4 — 0.3(u> — p)t-i — 0.06wt-3 — .002Trend t.

The dummy Adumt = [i86q2]t picks up the effect of a lock-out in 1986(2) and helps whiten the residuals.

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The wage-price block of the Area Wide Model

The unique feature of the AWM is that it treats the Euro area as a single econ­omy. Since the Euro was introduced only on 1 January 1999 and the information set underlying the estimation of the model—as documented in Fagan et al. (2001)—is a constructed data set covering the period 1970(1)-1998(4), the counterfactual nature of this modelling exercise is evident.

The AWM is used for forecasting purposes and the model has been specified to ensure that a set of structural economic relationships holds in the long run. It is constrained to be consistent with the neoclassical steady-state in which the long-run output is determined via a production function by exogenous techno­logical progress and the available factors of production, where the growth rate of labour force is exogenous...

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Evaluation of interest rate rules

10.3.1 A new measure—RMSTEs

Since we set the monetary policy instrument RSt in order to make a target variable xt stay close to its target level x*, it makes sense to evaluate the rules according to how well they achieve their objective. In the theoretical literature,

image214 image215

Figure 10.3. Ex post calculations of the implied interest rates from different
interest rate rules over the period 1995(1)-2000(4).

£(xt — x*)2 = J V [x] + (x — x* )2,


Подпись: RMSTE(x)

however, policy evaluation is often based on the unconditional variance of xt, denoted V [x]. An alternative measure which puts an equally large weight on the bias of the outcome, that is, on how close the expected value of xt is to the target x*, is the RMSTE...

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Inflation equations derived from the P*-model

The P*-model is presented in Section 8.5.4. The basic variables of the model are calculated in much the same way for Norway as for the Euro area in the previous section. Figure 8.16 shows the price gap (p — p*)t and the real money gap (rm — rm*)t along with the corresponding level series using Norwegian data. The price gap is obtained from equation (8.16) after first applying the HP filter to calculate equilibria for output (y*) and velocity (v*), respectively. As for the Euro area we have used A = 1600 to smooth the output series y* and A = 400 to smooth velocity v*. Then p* can be calculated from (8.14), as well as the price – and real money gaps. It is easily seen from the figure that (p — p*)t = —(rm — rm*)t.


The reference path for money growth A4mt is calculated in a ...

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Forecast comparisons

Both models condition upon the rate of unemployment ut, average labour productivity at, import prices pit, and GDP mainland output yt. In order to investigate the dynamic forecasting properties we enlarge both models with relationships for these four variables, in the same manner as in Chapter 9.

Figure 11.5 illustrates how the ICM-based model forecast the growth rates of wages and prices, Awt and Apt. It is also instructive to consider the forecasts for the change in the real wage A(w—p)t and the annual rate of inflation, A4pt. The forecast period is from 1995(1) to 1996(4). The model parameters are estimated on a sample which ends in 1994(4). These dynamic forecasts are conditional on the actual values of the non-modelled variables (ex post forecasts)...

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