Working Paper: CEPR ID: DP7070
Authors: Malin Adolfson; Stefan Lasen; Jesper Lind; Lars E.O. Svensson
Abstract: This paper studies the transmission of shocks and the trade-offs between stabilizing CPI inflation and alternative measures of the output gap in Ramses, the Riksbank's empirical dynamic stochastic general equilibrium (DSGE) model of a small open economy. The main results are, first, that the transmission of shocks depends substantially on the conduct of monetary policy, and second, that the trade-off between stabilizing CPI inflation and the output gap strongly depends on which concept of potential output in the output gap between output and potential output is used in the loss function. If potential output is defined as a smooth trend this trade-off is much more pronounced compared to the case when potential output is defined as the output level that would prevail if prices and wages were flexible.
Keywords: Impulse responses; Instrument rules; Open-economy DSGE models; Optimal monetary policy; Output gap; Potential output
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary policy conduct (E52) | transmission of shocks to the economy (F41) |
| optimal monetary policy (E63) | stabilization of CPI inflation (E31) |
| optimal monetary policy (E63) | stabilization of output gap (E63) |
| estimated instrument rule (C51) | inefficiency relative to optimal policy (H21) |
| optimizing response coefficients in the instrument rule (C51) | improvement in performance (D29) |
| zero lower bound on nominal interest rates (E43) | constraints on the central bank's ability to stabilize inflation (E52) |
| zero lower bound on nominal interest rates (E43) | constraints on the central bank's ability to stabilize output gap (E52) |