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The Global Economic Model (GEM) was developed by a team in the IMF’s Research Department led by Paolo Pesenti and Douglas Laxton. The authors wish to thank Chris Erceg, Chris Gaust, and Luca Guerrieri at the Federal Reserve Board for countless discussions and comments, and Tam Bayoumi, Peter Isard, and Ken Rogoff for encouraging this project. The authors also acknowledge the invaluable input of Michel Juillard and Susanna Mursula in developing some of the numerical procedures used in the quantitative analysis of the model, and thank Tam Bayoumi, Matthew Canzonieri, Giancarlo Corsetti, Luca Dedola, Margarida Duarte, Jordi Gali, Fabio Ghironi, Mads Kieler, Jaewoo Lee, Hali Edison, Doug Laxton, Paolo Pesenti, and seminar participants at the Bank of Canada, Bank of Italy, Georgetown University, the IMF, and the 2003 Summer Meeting of the North American Econometric Society for their useful comments. Remaining errors are of the authors.
The one-good, NOEM model developed by Erceg, Guerrieri, and Gaust (2002) at the Federal Reserve Board and the closed economy model of the euro area developed by Smets and Wouters (2002) at the ECB are the closet comparators of GEM.
See Lee and Tang (2003) for a fresh look at the empirical evidence on productivity and the real exchange rate.
While GEM has more sources of potential disturbance than the two analyzed in the paper, note that no other shock in addition to the two mentioned underpins the simulation results reported in this paper.
Following Erceg, Guerrieri, and Gaust (2002), we assume that it is costly to change the share of the imported goods in total production. Unlike them, we assume that it is costly for the firm to adjust its current imports/output ratio relatively to the past aggregate imports/output ratio.
The model can be easily re-interpreted as if households consumed directly a basket A of domestic and imported final goods. In this case γ and ν would be interpreted as preference parameters.
Because GEM’s steady state has no growth, these ratios are lower than they would normally be in the presence of growth
Empirical studies of the price elasticity of import demand such as Hooper and Marquez (1995) report a median value of 0.6 for Japan, Germany, and the United Kingdom. Gali and Monacelli (2002) choose a unitary value as their baseline. Others, including Chari, Kehoe and McGrattan (2001) and Smets and Wouters (2002), set the elasticity of substitution between Home and Foreign goods at 1.5
The sacrifice ratio is defined as the cumulative annual output gap that is required to permanently reduce inflation by one percentage point. A sacrifice ratio of 1.2 is consistent with that implied by the FRB/US model under rational expectations.
These algorithms were programmed in portable TROLL by Susanna Mursula, at the IMF. See Juillard and Laxton (2003) for a more detailed description of these algorithms.
Breaking down the productivity shock analyzed in intermediate and semi-finished good components and investigating its diffusion to the whole economy is beyond the scope of this paper, but would be feasible in GEM and a natural extension of this work.
Some minor changes to the baseline calibration are required to eliminate non-tradable goods from the model. Specifically, γ is increased to unity and η is set to zero in both the Home and the Foreign economy. The home bias parameter, v is set to 0.958 to obtain an import-to-GDP ratio of 0.13. The Home country’s capital share αT is set to 0.33 to achieve an investment-to-GDP ratio of 20 percent. The shock is also scaled appropriately so that it has the same long-run effect on the level of output
The model is calibrated with no distribution sector (η = η*= 0) and no home bias (v= 0.25 and v* = 0.75) to achieve this.
We are grateful to Christopher Erceg, Luca Guerrieri and Christopher Gust for providing us with their Troll code for the implementation of the Kalman filter to solve their signal extraction problem. Note that Hunt (2002) also considers how slowly evolving expectations about the persistence of the shock affect the model’s response to a productivity disturbance. Hunt (2002), however, does not embed a signal extraction mechanism in the model, but rather hard codes alternative expectation paths.
It is appealing to assume that the two shocks are correlated. If we interpret the shock to the uncovered interest parity as capturing “capital flows” factors that would have obtained following a productivity shock in a model with international trade in equities, then agents’ expectations about the persistence of the two shocks should be correlated. On equity trade in a NOEM model, see, for instance, Ghironi, Lee, and Rebucci (2003).
The Home household maximization problem is spelled out below.
We adopt the notation of Obstfeld and Rogoff (1996, chapter 10). Specifically, our timing convention has Bt(j) and
Alternative approaches to guarantee stationarity rely on parametric assumptions as in Corsetti and Pesenti (2001a,b), time-varying discount rates or demographic dynamics as discussed by Benigno (2001) and Ghironi (2003).
If the shocks ZI,
This specification facilitates the comparison with Taylor-style rules in log-linearized models.