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The author would like to thank Tamim Bayoumi, Douglas Laxton, James Morsink, and Paolo Pesenti for helpful discussions and comments. The author also thanks Jared Bebee for preparing the figures.
This precise calibration choice is somewhat arbitrary, but reflects the fact that, on average, final consumption in the United States is more energy intensive than in the rest of the world.
Ideally it should be costly to adjust the use of the intermediate input in final goods production and this extension is planned for the future.
These algorithms were programmed in portable TROLL by Susanna Mursula, at the IMF.
To generate flexible-price output, the complete model is replicated with all the parameters determining the nominal adjustment cost set to zero. This structure is simulated simultaneously with the sticky-price structure and the flexible-price level of GDP is used as the policymaker’s estimate of potential output in the computation of the output gap entering the policy rule.
In the short-run the flexible price level of potential output falls much more than the long-run level for two reasons. First, initially real energy price rise by almost 300 percent, but in the long-run are up by under 100 percent, Second, adjustment cost in intermediate goods production imply that the short-run elasticity of substitution between energy and capital and labor is lower than in the long-run, which is calibrated to be Cobb Douglas.