|Structural estimation of the New-Keynesian model: a formal test of backward- and forward-looking behavior|
|Abstract||This paper attempts to uncover
the empirical relationship between the price-setting/consumer behavior
and the sources of persistence in inflation and output. First, a
small-scale New-Keynesian model (NKM) is examined using the method of
moment and maximum likelihood estimators with US data from 1960 to 2007.
Then a formal test compares the fit of two competing specifications in
the New-Keynesian Phillips Curve (NKPC) and the IS equation; i.e.
forward- or backward-looking behavior. Accordingly, the inclusion of a
lagged term in the NKPC and the IS equation improves the fit of the
model while offsetting the influence of inherited and extrinsic
persistence; it is shown that intrinsic persistence plays a major role
in approximating the inflation and output dynamics for the Great
Inflation period. However, the null hypothesis cannot be rejected at the
5% level for the Great Moderation period; i.e. the purely
forward-looking behavior of the NKM and its hybrid variant are
equivalent. Monte Carlo experiments illustrate the validity of the
chosen moment conditions and the finite sample properties of classical
estimation methods. Finally, the performance of the formal test is
analyzed using the Akaike’s and the Bayesian information criterion.
Keywords: backward- and forward-looking behavior, formal test, information criterion, intrinsic persistence, maximum likelihood, method of moment, New-Keynesian
JEL classification: C12, C32, E12