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DSGE Modelling at Central Banks: Country Practices and How it is Used in Policy Making

DSGE Modelling at Central Banks: Country Practices and How it is Used in Policy Making. Haris Munandar Bank Indonesia. SEACEN-CCBS/BOE-BSP Workshop on DSGE Modelling and Econometric Techniques Manila, 27 November 2009. BISMA: Bank Indonesia Structural MAcro model.

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DSGE Modelling at Central Banks: Country Practices and How it is Used in Policy Making

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  1. DSGE Modelling at Central Banks: Country Practices and How it is Used in Policy Making Haris Munandar Bank Indonesia SEACEN-CCBS/BOE-BSP Workshop on DSGE Modelling and Econometric Techniques Manila, 27 November 2009

  2. BISMA: Bank Indonesia Structural MAcro model • Implementation of a full-fledged Inflation Targeting Framework (ITF) on July 2005 necessitates support by a model with the following features: • capturing supply and demand side very well • more resistant to Lucas critique • incorporating rational expectation explicitly through optimization behaviour of economic agents • incorporating forward-looking endogenous interest rate reaction • ability to be utilized in policy simulation and forecasting

  3. Role of economic models in Bank Indonesia

  4. Outline • Specification and model structure • Behaviour of agents • Market clearing conditions and identities • Data and methodology • Estimation, calibration and IRF • Forecasting and simulation results

  5. Specification Micro-founded Macroeconomic model (DSGE). • New Keynesian – Neoclassical Synthesis: • Long run neoclassical steady state (neutrality of money) • Short-run Keynesian dynamics • Rational expectation • Nominal rigidities : price and wage staggered contract ala Rotemberg • Real rigidities : habit formation in consumption, and adjustment cost in capital • Interest rate reaction function (Taylor Rule) secara endogen danforward lookingsejalandenganpenerapan ITF • Two core economic agents (households and firms) and 3 auxiliary economic agents (central bank, government and foreign/rest of the world),

  6. Model structure

  7. Outline • Specification and model structure • Behaviour of agents • Market clearing conditions and identities • Data and methodology • Estimation, calibration and IRF • Forecasting and simulation results

  8. Household • Own assets (domestic and foreign bond); purchase finished goods and investment goods; receive wages as return for labor supplied to firms; receive rental capital from firms; and receive profits from firm • Objective Function: • Budget Constraints:

  9. Household • Investment increase the capital stock over time according to Capital Accumulation eq : • Wage Setting • The labor aggregator solve: where is the flexible-price optimal nominal wage and are in logs

  10. Household: log-linear solution • Consumption • Flexible Wage • Investment where • Shadow Price of Capital

  11. Household: log-linear solution • Capital Supply • Uncovered Interest Parity • Wage Inflation where

  12. Domestic Intermediate Firm • Assumption : Monopolistically competitive firms with Cobb-Douglas • Production Function : • Profits • Price Setting The price aggregator solve: where is the flexible-price and are in logarithmic • Flexible price

  13. Domestic intermediate firm: log-linear solution • Output • Labor demand • Capital demand • PPI inflation • where

  14. Consumption goods producer • Consumption goods producer • Profit • Price setting The price aggregator solve: where is the flexible-price and are in log • Flexible - consumption goods producer’s price:

  15. Cons. goods producer: log-linear solution • Consumption goods • Domestic consumption intermediate demand • Imported consumption intermediate demand • CPI inflation • where

  16. Investment goods producer • Assumption Producing investment goods from imported materials • Investment Goods Producer • Profit

  17. Invest. goods producer: log-linear solution • Investment goods • Investment goods price

  18. Government goods producer • Assumption Producing government goods from domestic materials • Government goods producer • Profit Government goods producer: log-linear solution • Government goods

  19. Export goods producer • Export goods producer • Profit • Price Setting The price aggregator solve: where is the flexible-price and are in log • Flexible - export goods producer’s price:

  20. Export goods producer: log-linear solution • Export goods • Domestic export intermediate demand • Imported export intermediate demand • Export price inflation • where

  21. Importers Importers • Provide imported materials as intermediate inputs to final good production • Only act like merchants – no production function • The price aggregator solve: where is the flexible-importer’s price and are in log • Flexible - import’s price:

  22. Importer: log-linear solution • Imported Inflation • where

  23. Central bank Central bank • Central bank objective function is to set the nominal short term interest rate it in response to deviations of inflation from the target as well as output gap

  24. Government • Government fiscal authority • For simplification: government chooses the current government expenditure by smoothing previous government expenditure • However, it has to consider the source of financing from taxes, and bond issuance

  25. Balance of payment • Balance of Payment • Balance of payment equation is the result of interactions among all agents, which has connection with foreign sectors

  26. Outline • Specification and model structure • Behaviour of agents • Market clearing conditions and identities • Data and methodology • Estimation, calibration and IRF • Forecasting and simulation results

  27. Market clearing conditions and identities • Export: • Import: • Dom. Intermediate Goods : • Nominal GDP :

  28. Market clearing conditions and identities • Risk Premium : • Foreign Economy : • Technology Growth

  29. Outline • Specification and model structure • Behaviour of agents • Market clearing conditions and identities • Data and methodology • Estimation, calibration and IRF • Forecasting and simulation results

  30. Data and methodologi • Data • Kuartalan : 2000 Q1 – 2009 Q2 • Solving Rational Expectation • Generalized Schur Decomposition (Klein, 2000) • Estimation • Bayesian • Robustness Check • Impulse Response Function (IRF)

  31. Outline • Specification and model structure • Behaviour of agents • Market clearing conditions and identities • Data and methodology • Estimation, calibration and IRF • Forecasting and simulation results

  32. Parameter estimation

  33. Parameter calibration

  34. IRF – unfavorable inflation shock Shock

  35. IRF – exchange rate depreciation shock Shock

  36. IRF – favorable foreign demand shock Shock

  37. IRF – tight policy Shock

  38. Outline • Specification and model structure • Behaviour of agents • Market clearing conditions and identities • Data and methodology • Estimation, calibration and IRF • Forecasting and simulation results

  39. Simulation result: loose policy vs. baseline

  40. Simulation result: loose policy vs. baseline

  41. Simulation result: tight policy vs. baseline

  42. Simulation result: tight policy vs. baseline

  43. THANK YOU

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