Transcript AN ESTIMATED NEW KEYNESIAN POLICY MODEL FOR THE …

AN ESTIMATED NEW KEYNESIAN POLICY
MODEL FOR THE CZECH REPUBLIC
Aleš Melecký
Department of Economics
Technical University of Ostrava
Outline of the Presentation
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Motivation
Model
Data and Estimation Method
Estimation Results
Preview
– Impulse Response Analysis
– From inflation to exchange rate targeting
• Conclusions
Motivation
• Regional monetary integrations, including the
Czech Republic’s integration into EMU
• From IT to ERT
• Description of Czech economy and identification
of shocks
• Identification of transmision channels
The employed model’s features
• Two blocks:
– a small open economy (the Czech Republic)
– the rest of the world (euro area economy)
• New Keynesian policy model with rational
expectations
• Relaxed cross-equation coefficient restrictions
• Empirically determined lag structure of the
transmission mechanism
Model Equations – Domestic Block
• Phillips curve – inflation dynamics
• IS curve – output gap dynamics
• MP reaction function – interest rate dynamics
• UIP equation – exchange rate dynamics
Model Equations – Foreign Block
Data
• Quarterly data series
– 1995Q1 to 2007Q4 for the Czech Republic
– 1981Q1 to 2007Q4 for the euro area
• Data Sources
– Datastream, Czech National Bank statistics,
Fagan et al. (2001)(extrapolation back to
1981 for the euro area using growth rates)
Data
• Output gap
– Deviation of the log GDP from its trend, estimated by
the HP-filter and multiplied by 100
• Inflation
– Annualized percentage changes in CPI for the Czech
Republic and harmonized CPI for the euro area
• Interest rate
– Three-month PRIBOR for the Czech Republic
– Three-month EURIBOR for the euro area
• Real exchange rate CZK/EUR
– Cross exchange rate using synthetic USD/EUR rate
and CZK/USD rate, times CPIs ratio, in logs, linearly
detrended, and multiplied by 100
Estimation method
• Choose GMM over MLE-based methods to ensure
higher robustness of estimates against possible
misspecification
• Up to three lags of variables in the system used as
instruments
• HAC estimated using the Bartlett kernel with the variable
Newey-West bandwidth selection
• Pre-whitening of moment conditions applied
• BIC used for lag-length selection
Estimation Results
Estimation Results – Phillips curve
• Inflation process more forward- than backward-looking
both in CR and EA
• Sensitivity of inflation to demand pressures, almost three
times higher in CR than EA
• Significant estimate of
implies that Czech firms
incorporate expected changes in excess demand into
current prices (1% for 10%)
• ER pass-through – a 10 % increase in CZK/EUR
expected to result in a 1.2 % increase in Czech inflation
• CR is estimated to face more than three times larger
supply shocks than EA
• Data fit lower for CR (adj.R2 0.25) than for EA (adj.R2
0.83) -- less observations and the transition in CR
Estimation Results – IS curve
• Output gap rigidity apparent in both countries (rho_y<0)
• Real interest rate elasticity fairly similar in CR and EA
• Interest rate transmission channel about two-times
longer in EA than CR (6 vs. 3 periods)
• Exchange rate transmission channel (2-period lag) faster
than IR transmission channel in CR
• Exchange rate elasticity estimated to be smaller than
interest rate elasticity
• a 10 % increase in EA demand estimated to result in a 4
% increase in Czech output
• Data fit of OE-IS curve for CR (adj.R2 0.89) slightly
better than CE-IS curve for EA (adj.R2 0.83)
• IS shocks’ size appears to be marginally higher in CR
than EA
Estimation Results – MP rule
• CNB and ECB smooth their interest rates, where ECB
policy rate shows slightly more inertia
• ECB reaction to expected inflation appears to be higher
than that of CNB
• ECB appears to place less weigh on output gap in its
reaction function than CNB
• ECB – a more conservative central banker than CNB
• MP shocks in CR more than four times larger than in EA,
i.e. ECB applies significantly less discretion than CNB
• Both MP reaction functions fit data well adj.R2 for CR
0.84 and for EA 0.98
Estimation Results - UIP
• The estimated UIP equation implies that the standard
deviation of the exchange rate shock is 5.86
• ER shock is thus the largest shock in the system
• Also, estimated to be significantly positively correlated
over time
Impulse Response Analysis
• How domestic (Czech) economic variables respond to
individual structural shocks, both domestic and external
• The estimated system of equations with rational
expectations solved into an VAR form using QZ
algorithm of Sims (2002)
• The reduced-form used to generate impulse responses
of domestic variables to selected shocks
Impulse Response Analysis
• Domestic IS shock hits the Czech economy
• IS shock »↑output gap » ↑inflation » CNB reacts and
↑interest rate » ↑interest rate differential between CR
and EA » CZK appreciates against EUR » the IR hike
and CZK appreciation bring the output gap and inflation
back to their steady-states
Impulse Response Analysis
• Domestic AS shock hits the Czech economy
• AS shock » ↑inflation » CNB ↑interest rate » CZK
appreciates against EUR » ↓output gap into negative
values » IR and output gap return to steady states, CZK
depreciates against EUR and settles around its steady
state
Impulse Response Analysis
• Domestic MP shock hits the Czech economy
• MP shock » CNB ↑interest rate » ↓ inflation » ↑ real
interest rate differential between CR and EA » CZK
strongly appreciates against EUR » output gap contracts
significantly as a result of lower external price
competitiveness
Impulse Response Analysis
• Foreign IS shock hits the Czech economy
• Foreign IS shock » ↑foreign demand » ↑Czech output
gap» ↑inflation & ↑EA inflation » CNB & ECB ↑interest
rate » positive real IR differential for CZK » CZK
appreciates » inflation ↓ faster in CR » real IR peaks
sooner » higher IR in EA » EUR appreciates against
CZK before settling at its steady state
Impulse Response Analysis
• Foreign AS shock hits the Czech economy
• Foreign AS shock » ECB ↑interest rate » ↑real interest rate »
CZK depreciates against EUR » ↑ Czech net exports and
output gap » ↑Czech inflation » CNB ↑interest rate » ↓real
interest rate differential » CZK depreciation slows down »
different intensity of CNB &ECB reactions and lengths of the
monetary transmission » swings of the Czech variables before
reaching steady states
Impulse Response Analysis
• Foreign MP shock hits the Czech economy
• Foreign MP shock » ↑ EA real interest rate » depreciation of
CZK against EUR » ↑net exports » Czech output gap positive
» ↑ inflation » Czech output gap peaks & quickly returns to
steady state » rapid adjustment causes a period of deflation »
CNB ↓ interest rate » inflation returns back to its steady state
Impulse Response Analysis
• Exchange rate shock hits the Czech economy
• Exchange rate shock » short CZK appreciation against EUR »
negative Czech output gap & ↓ inflation » Czech output gap
expected to adjust back fast » positive output gap adjustment
» short-lived ↑ inflation » initially CNB ↑ interest rate » after
several quarters CNB ↓interest rate to smooth out ER
response which returns to zero in about 13 quarters
From inflation to exchange rate
targeting
• Estimating CB´s loss function
• Optimalization of inflation targeting and
movement to exchange rate targeting
• More in our article: From Inflation to Exchange
Rate Targeting: Estimating the Stabilization
Effects for a Small Open Economy
(Ales Melecky and Martin Melecky)
Conclusions
Model Estimation
• Pricing of firms in the Czech Republic shows higher
rigidity than pricing of firms in EA
• ECB appears to be a more conservative central banker
with higher MP rate inertia compared with the CNB
• The interest rate transmission channel of MP is
significantly shorter in CR than EA
• A foreign demand shock has the highest impact on the
Czech economy, higher than an ER shock or any
domestic shock
• Out of the domestic shocks, the supply shock appears to
be the most influential
Thank you!
[email protected]