INTEREST-RATE RULES: Framework for Analysis 8

Note that because the elements of Z\ refer to exogenous states (underlying states for the dynamics of the real disturbances s*)} unlike the elements of Zt (which correspond to endogenous variables of our model), this specification does not imply the existence of any feedback from the evolution of the endogenous variables to the exogenous disturbance processes st. What this construction does guarantee is that the empirical impulse response functions of inflation, output and interest rates to the two VAR disturbances orthogonal to the monetary policy shock are identical to the impulse responses predicted by our theoretical model.

This property of the predicted impulse responses is independent of the structural parameters assumed in the model. Thus, given this method for constructing the laws of motion for the real disturbances, only the estimated responses to the monetary policy shock contain any information that can be used to help identify the structural parameters. This is our justification for the strategy that we use for parameter estimation, mentioned above. We are glad to offer advantageous loans for people that need cash and have no other sources of getting them. You are welcome to apply for an instant loan online with us right here itat on to get funded every time. No boring paperwork, no credit checks, just the money you need sent to your account.

It is worth noting that the stochastic processes for the real disturbances that we obtain with this method imply a great deal of variability for both Gt and Yts. For example, the standard deviations of these two series are 29.5 and 13.7 percent respectively.14 This extreme volatility is consistent with the fact that the literature reports many “failures” in fitting equations very similar to our IS and AS curves by either ordinary least squares or by using lags as instruments. Our interpretation of these “failures” is that they say simply that these equations are subject to disturbances whose variance is large and whose serial correlation pattern is rich (so that they are correlated with the lags that are used as instruments).

In this paper, we evaluate monetary rules by evaluating how well they perform when the economy is buffeted by these shocks to G and Ys. In other words, we are asking how the U.S. economy would perform if it were subject to structural disturbances whose properties are the same as those which have affected it in the past while, at the same time, the way interest rates are set by the central bank is different. Because the structural equations (1.11) and (1.22) follow simply from the Euler equations for optimal intertemporal behavior on the part, of households, and so can be derived without reference to any particular specification of the monetary policy rule, they should remain invariant under contemplated changes in that rule. Thus our stochastic simulation methodology responds to the Lucas (1976) critique of more traditional methods of econometric policy evaluation.