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Exercise 2
Step 1: Get the equations from the problem set and log-linearise them as
Walsh does in his book.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
0 < a < 1; b,
η, φ, A > 0.
Production function
So
but
,so
Hence,
and
so
Define
so
where and
Money holdings
Euler condition
Fisher equation
%% Parameters
% "Technology" parameters
p.N_bar = 1/3; % steady state employment is a third of total time endowment
p.alpha = .36; % Capital share
p.delta = .019; % Depreciation rate for capital
%"Taste" parameters
p.beta = .98; % discount parameters
p.PHI = 2; % coefficient of relative risk aversion
p.eta = 1; % leisure parameter
% Next two parameters are used for the MIU model but not for the CIA model
p.b = 2.56; % interest elasticity
p.a = 0.95; %
p.THETA = 1; % rate of money growth (gross)
%Check: 12 variables.
%Endogenous state variables "x(t)": k(t), m(t)
%Endonenous other variables "y(t)": y(t), c(t), n(t), lambda(t), i(t), r(t), inf(t), x(t).
%Exogenous state variables "z(t)": z(t), g(t).
%Switch to that notation. Find matrices for format
%0 = AA x(t) + BB x(t-1) + CC y(t) + DD z(t)
% 0 = E_t [FF x(t+1) + GG x(t) + HH x(t-1) + JJ y(t+1) ++ KK y(t) = LL z(t+1) + MM z(t)]
% z(t+1) = NN z(t) + epsilon (t+1) with E_t [ epsilon(t+1) ] = 0,
%
% Solution takes the form
% x(t) = PP*x(t-1) + SS*z(t)
% y(t) = RR*x(t-1) + QQ*z(t)
%equation order
%1). resource constraint
%2). production function
%3). money demand equation
%4). evolution of m
%5). labor market
%6). euler equation 1
%7). euler equation 2
%8). investment evolvement equation
%8). fisher equation
%9). ex-post real interest
AA = [1, 0
0, 0
0, 1
0, 1
0, 0
0, -p.OMEGA2
-p.alpha *(1-p.alpha)* p.YK_bar*(p.eta*p.NL_bar), 0
1, 0];
FF = zeros(2, 2);
GG = zeros(2, 2);
HH = zeros(2, 2);
JJ = zeros(2, 8);
JJ(1, 7) = 1;
JJ(2, 4) =1;
KK = [0, 0, 0, 0, -1, 1, 0, 0
0, 0, 0, -1, 0, 1, 0, 0];
LL = [0, 0
0, 0];
MM = [0, 0
0, 0];
NN = [p.rho_z, 0
p.phi, p.rho_u];
Sigma = [p.sigma_z^2 0
0 p.sigma_v^2];
HORIZON = 32; %how far out should the inpulse response be calculated
PERIOD = 4; %number of periods per year, i.e. 12 for monthly, 4 for quarterly
DO_PLOTS = 0; %if impulse response plots should be made, = 0, if not
% IMP_SELECT is a vector containing the indices of the variables to be plotted
IMP_SELECT = [ 3, 5, 6, 7]; % for money growth shock
%HP_SELECT = 1: (m_states + n_endog + k_exog); %selecting the variables for the HP filter calcs.
%GNP_INDEX = 1; %Index of output among the variables selected for HP filter
DO_MOMENTS = 1;
DISPLAY_AT_THE_END = 0;
%Start the calculations;
do_it;
if DO_DISP3,
disp('Standard deviations, HP-filtered series relative to output, cov with output:');
VARNAMES
disp([sqrt(varvec_fil)./sqrt(varvec_fil(3)) autcor_fil(1:12,6)]);
end;
Step 7: Analysis and cases
Benchmark: Optimal Inflation(was originally addressed by Bailey (1956) and M. Friedman
(1969))
• Private marginal cost of holding money is the nominal interest rate
• Social marginal cost of creating money is zero
At the steady state:
We could not set this benchmark because tetta will be equal betta and the equation
go to infinity.
Cases: