Abstract
We present a two-country New Open Economy Macro model of the Austrian economy within the European Union’s Economic & Monetary Union (EMU). The model includes both nominal and real frictions that have proven to be important in matching business cycle facts, and that allow for an investigation of the effects and cross-country transmission of a number of structural shocks: shocks to technologies, shocks to preferences, cost-push type shocks and policy shocks. The model is estimated using Bayesian methods on quarterly data covering the period of 1976:Q2–2005:Q1. In addition to the assessment of the relative importance of various shocks, the model also allows to investigate effects of the monetary regime switch with the final stage of the EMU and investigates in how far this has altered macroeconomic transmission. We find that Austria’s economy appears to react stronger to demand shocks, while in the rest of the Euro Area supply shocks have a stronger impact. Comparing the estimations on pre-EMU and EMU subsamples we find that the contribution of (rest of the) Euro Area shocks to Austria’s business cycle fluctuations has increased significantly.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
Masson and Taylor (1993) find that the European Union as a whole is a relatively closed area.
In reality, consumption baskets also contain a large fraction of non-tradable goods. To keep the model simple, we however abstract from explicitly modeling non-tradable goods. Nontradable consumption is implicitly reflected by a higher parameter weight on own consumption goods relative to a model in which nontradables are explicitly modeled.
That is, the foreign aggregate consumption index, for foreign household j *, is given by:
$$ C_{t}^{\ast }\left( j^{\ast }\right) =\left[ \gamma _{c}^{\ast \frac{1}{ \epsilon ^{\ast } }}C_{H,t}^{\ast \frac{\epsilon ^{\ast }-1}{\epsilon ^{\ast }}}\left( j^{\ast }\right) +(1-\gamma _{c}^{\ast })^{\frac{1}{\epsilon } }C_{F,t}^{\ast \frac{\epsilon ^{\ast }-1}{\epsilon ^{\ast }}}\left( j^{\ast }\right) \right] ^{\frac{\epsilon ^{\ast }}{\epsilon ^{\ast }-1}} $$Note that the price for investment goods, P X,t , may differ from the consumer price index, P t , as the weights that determine the composition between domestic and foreign goods may differ.
We assume that the domestic country’s government expenditure falls on domestic goods entirely, and, similarly, foreign government consumption falls entirely on foreign goods. The domestic and foreign demand for the h good is formally given by:
$$ \begin{aligned} y_{t}^{D}\left( h\right) =&\int\limits_{0}^{n}c_{t}\left( h,j\right) dj+\int\limits_{0}^{n}x_{t}\left( h,j\right) dj+\int\limits_{0}^{n}G_{t}\left( j\right) dj \\ y_{t}^{D\ast }\left( h\right) =&\int\limits_{n}^{1}c_{t}^{\ast }\left( h,j\right) dj^{\ast }+\int\limits_{n}^{1}x_{t}^{\ast }\left( h,j^{\ast }\right) dj^{\ast } \end{aligned} $$Note that when prices are flexible Eq. 35 reduces to the standard expression of the price as a markup over current marginal costs:
$$ p_{t}\left( h\right) =\frac{\theta }{\left( 1-\theta \right) } MC_{t}^{nom}\left( h\right) $$This proposed rule for the public sector is clearly much stricter than the one implied by the Stability and Growth pact. Ratto et al. (2007) propose a model in which European fiscal policy issues are more specifically addressed.
Please refer to our working paper version (Breuss and Rabitsch 2008) for a more explicit description of the log-linearized model.
The updated AWM database starts in 1970:Q1 (for most variables) and is available until 2005:Q4.
In particular, we make use of Klein’s (2000) Matlab file ‘solab.m’.
It is a ‘Markov-Chain’ Monte Carlo algorithm because each proposal is drawn from a density that depends only on the previous draw.
The weights are based on constant GDP at market prices (PPP) for the EU-11 for 1995.
The MCMC algorithm was run with 50000 draws.
References
Adolfson M, Laseen S, Linde J, Villani M (2007) Bayesian estimation of an open economy DSGE model with incomplete pass-through. J Int Econ 72(2):481–511
Blanchard OJ, Kahn CM (1980) The solution of linear difference models under rational expectations. Econometrica 48(5):1305–1312
Breuss F, Rabitsch K (2008) An estimated two-country DSGE model of Austria and the Euro Area, Europainstitut, Vienna University of Economics and Business Administration, Working Paper 78, June 2008
Christiano LJ (2002) Solving dynamic equilibrium models by a methods of undetermined coefficients. Comput Econ 20(1–2):21–55
Christiano L, Eichenbaum M, Evans C (2001) Nominal rigidities and the dynamic effects of a shock to monetary policy. NBER Working Paper (w8403)
Del Negro M, Schorfheide F, Smets F, Wouters R (2007) On the fit and forecasting performance of New Keynesian models. J Bus Econ Stat 25:123–162
Erceg CJ, Henderson DW, Levin A (2000) Optimal monetary policy with staggered wage and price contracts. J Monet Econ 46(2):281–313
Fagan G, Henry J, Mestre R (2001) An area-wide model (AWM) for the Euro Area. European Central Bank, Working Paper (42)
Galí J (1999) Technology, employment, and the business cycle: Do technology shocks explain aggregate fluctuations? Am Econ Rev 89(1):249–271
Geweke J (1999) Computational experiments and reality. Society for Computational Economics. Computing in economics and finance (401)
King RG, Watson MW (1998) The solution of singluar linear difference systems under rational expectations. Int Econ Rev 39(4):1015–1026
Klein P (2000) Using the generalized Schur form to solve a multivariate linear rational expectations model. J Econ Dyn Control 24(10):1405–1423
Kollmann R (2001) The exchange rate in a dynamic-optimizing business cycle model with nominal rigidities: a quantitative investigation. J Int Econ Elsevier 55(2):243–262
Leitner SM (2007) The Austrian business cycle—a characterization. Johannes Kepler University, Department of Economics Working Paper (0717)
Lubik T, Schorfheide F (2007) A Bayesian look at New Open Economy Macroeconomics. Economics Working Paper Archive. The Johns Hopkins University (521)
Masson PR, Taylor MP (1993) Currency unions: a survey of the issues. In: Policy issues in the operation of currency unions. Cambridge University Press, Cambridge
Pytlarczyk E (2005) An estimated DSGE model for the German economy within the Euro Area. Discussion Paper Series 1: Economic Studies 2005, Deutsche Bundesbank (33)
Ratto M, Roeger W, in’t Veld J (2007) The stabilising power of fiscal policy in an estimated open-economy model for the Euro Area. Joint Research Centre and DG ECFIN, European Commission (mimeo)
Schorfheide F (2000) Loss function based evaluation of DSGE models. J Appl Econom 15(6):645–670
Sims CA (2002) Solving linear rational expectations models. Comput Econ 20(1–2):1–20
Smets F, Wouters R (2003) An estimated stochastic dynamic general equilibrium model of the euro area. J Eur Eco Assoc 1(5):1123–1175
Smets F, Wouters R (2004) Forecasting with a bayesian DSGE model: an application to the euro area. European Central Bank, Working Paper Series 389
Uhlig H (1999) A toolkit for analyzing non-linear dynamic stochastic models easily. In: Marimón R, Scott A (eds) Computational methods for the study of dynamic economies. Oxford University Press, Oxford
Acknowledgements
We are grateful for valuable comments from Jorge Fornero and Sebastian Watzka, as well as from participants at the 2008 NOeG Conference of the Austrian Economic Association in Vienna, Austria. We also thank Marcus Scheiblecker at the Austrian Institute of Economic Research for providing us with Austrian data revised back to 1976.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Breuss, F., Rabitsch, K. An estimated two-country DSGE model of Austria and the Euro Area. Empirica 36, 123–158 (2009). https://doi.org/10.1007/s10663-008-9095-y
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10663-008-9095-y