A Study of a New-Keynesian DSGE Macro Model: Estimates, Shocks, and Optimal Monetary Policy

Abstract: This paper estimates and simulates a New-Keynesian small-scale DSGE macro model. The model consists of the hybrid forms of the Phillips curve and the IS curve, and is closed with a Taylor-type feedback rule allowing partial adjustment of the monetary policy instrument. We estimate the three-equation system simultaneously on Swedish data 1995:Q1 to 2014:Q4 with the FIML estimator. The empirical parameter values are then used in simulations of the model to study the impact of shocks and optimize the policy rule by using an objective function. Our estimates indicate that both inflation and output possess a significant forward-looking behavior, and that the policy instrument is adjusted in a gradual manner. A sensitivity analysis of the magnitude of interest rate smoothing suggests a trade-off that the Central Bank faces when exogenous disturbances move the economy. In attempting to gauge preferences of monetary policy, we show that an optimized policy rule that roughly returns the historical rule is characterized by that the monetary authority in descending order stabilizes the volatility of the interest rate, the output gap and inflation from a target level.