Contents
List of Figures xv
List of Tables xix
List of Abbreviations xxi
1 Introduction 1
1.1 The case for macroeconometric models 1
1.2 Methodological issues (Chapter 2) 4
1.3 The supply-side and wage- and price-setting
(Chapters 3–8) 7
1.4 The transmission mechanism (Chapters 9 and 10) 11
1.5 Forecast properties (Chapter 11) 15
2 Methodological issues of large-scale macromodels 17
2.1 Introduction: small vs. large models 17
2.2 The roles of statistics and economic theory
in macroeconometrics 20
2.2.1 The influx of statistics into economics 20
2.2.2 Role of economic theory in
macroeconometrics 22
2.3 Identifying partial structure in submodels 24
2.3.1 The theory of reduction 24
2.3.2 Congruence 26
2.4 An example: modelling the household sector 29
2.4.1 The aggregate consumption function 30
2.4.2 Rival models 31
2.5 Is modelling subsystems and combining them to
a global model a viable procedure? 32
3 Inflation in open economies: the main-course model 35
3.1 Introduction 35
3.2 Cointegration 37
3.2.1 Causality 41

3.2.2 Steady-state growth 42
3.2.3 Early empiricism 42
3.2.4 Summary 43
4 The Phillips curve 45
4.1 Introduction 45
4.1.1 Lineages of the Phillips curve 46
4.2 Cointegration, causality, and the Phillips curve natural rate 47
4.3 Is the Phillips curve consistent with persistent
changes in unemployment? 52
4.4 Estimating the uncertainty of the Phillips curve NAIRU 54
4.5 Inversion and the Lucas critique 56
4.5.1 Inversion 56
4.5.2 Lucas critique 57
4.5.3 Model-based vs. data-based expectations 59
4.5.4 Testing the Lucas critique 61
4.6 An empirical open economy Phillips curve system 62
4.6.1 Summary 72
5 Wage bargaining and price-setting 73
5.1 Introduction 73
5.2 Wage bargaining and monopolistic competition 74
5.3 The wage curve NAIRU 78
5.4 Cointegration and identification 79
5.5 Cointegration and Norwegian manufacturing wages 82
5.6 Aggregate wages and prices: UK quarterly data 86
5.7 Summary 87
6 Wage–price dynamics 89
6.1 Introduction 89
6.2 Nominal rigidity and equilibrium correction 90
6.3 Stability and steady state 92
6.4 The stable solution of the conditional wage–price system 95
6.4.1 Cointegration, long-run multipliers,
and the steady state 97
6.4.2 Nominal rigidity despite dynamic homogeneity 98
6.4.3 An important unstable solution: the ‘no wedge’ case 99
6.4.4 A main-course interpretation 100
6.5 Comparison with the wage-curve NAIRU 102
6.6 Comparison with the wage Phillips curve NAIRU 104
6.7 Do estimated wage–price models support the NAIRU
view of equilibrium unemployment? 105
6.7.1 Empirical wage equations 105

6.7.2 Aggregate wage–price dynamics in
the United Kingdom 107
6.8 Econometric evaluation of Nordic structural
employment estimates 108
6.8.1 The NAWRU 109
6.8.2 Do NAWRU fluctuations match up with
structural changes in wage formation? 111
6.8.3 Summary of time varying NAIRUs in
the Nordic countries 116
6.9 Beyond the natural rate doctrine:
unemployment–inflation dynamics 117
6.9.1 A complete system 117
6.9.2 Wage–price dynamics: Norwegian manufacturing 119
6.10 Summary 123
7 The New Keynesian Phillips curve 127
7.1 Introduction 127
7.2 The NPCM defined 129
7.3 NPCM as a system 130
7.4 Sensitivity analysis 134
7.5 Testing the specification 136
7.5.1 An encompassing representation 136
7.5.2 Testing against richer dynamics 137
7.5.3 Evaluation of the system 139
7.5.4 Testing the encompassing implications 141
7.5.5 The NPCM in Norway 144
7.6 Conclusions 145
8 Money and inflation 147
8.1 Introduction 147
8.2 Models of money demand 148
8.2.1 The velocity of circulation 148
8.2.2 Dynamic models 150
8.2.3 Inverted money demand equations 150
8.3 Monetary analysis of Euro-area data 151
8.3.1 Money demand in the Euro area 1980–97 151
8.3.2 Inversion may lead to forecast failure 152
8.4 Monetary analysis of Norwegian data 155
8.4.1 Money demand in Norway—revised and
extended data 155
8.4.2 Monetary effects in the inflation equation? 159
8.5 Inflation models for the Euro area 161
8.5.1 The wage–price block of the Area Wide Model 162
8.5.2 The Incomplete Competition Model 163

8.5.3 The New Keynesian Phillips Curve Model 163
8.5.4 The P∗-model of inflation 164
8.6 Empirical evidence from Euro-area data 166
8.6.1 The reduced form AWM inflation equation 166
8.6.2 The reduced form ICM inflation equation 167
8.6.3 The P∗-model 169
8.6.4 The New Keynesian Phillips curve 174
8.6.5 Evaluation of the inflation models’ properties 175
8.6.6 Comparing the forecasting properties of
the models 178
8.6.7 Summary of findings—Euro-area data 181
8.7 Empirical evidence for Norway 182
8.7.1 The Incomplete Competition Model 182
8.7.2 The New Keynesian Phillips curve 183
8.7.3 Inflation equations derived from the P∗-model 185
8.7.4 Testing for neglected monetary effects
on inflation 188
8.7.5 Evaluation of inflation models’ properties 190
8.7.6 Comparing the forecasting properties of the models 192
8.7.7 Summary of the findings—Norway vs. Euro area 196
9 Transmission channels and model properties 199
9.1 Introduction 199
9.2 The wage–price model 202
9.2.1 Modelling the steady state 202
9.2.2 The dynamic wage–price model 204
9.3 Closing the model: marginal models for feedback variables 207
9.3.1 The nominal exchange rate vt 207
9.3.2 Mainland GDP output yt 210
9.3.3 Unemployment ut 210
9.3.4 Productivity at 211
9.3.5 Credit expansion crt 212
9.3.6 Interest rates for government bonds RBOt and
bank loans RLt 213
9.4 Testing exogeneity and invariance 214
9.5 Model performance 216
9.6 Responses to a permanent shift in interest rates 220
9.7 Conclusions 222
10 Evaluation of monetary policy rules 225
10.1 Introduction 225
10.2 Four groups of interest rate rules 227
10.2.1 Revisions of output data: a case for
real-time variables? 229

10.2.2 Data input for interest rate rules 230
10.2.3 Ex post calculated interest rate rules 230
10.3 Evaluation of interest rate rules 231
10.3.1 A new measure—RMSTEs 231
10.3.2 RMSTEs and their decomposition 232
10.3.3 Relative loss calculations 237
10.3.4 Welfare losses evaluated by response
surface estimation 240
10.4 Conclusions 243
11 Forecasting using econometric models 245
11.1 Introduction 245
11.2 EqCMs vs. dVARs in macroeconometric forecasting 249
11.2.1 Forecast errors of bivariate EqCMs and dVARs 250
11.2.2 A large-scale EqCM model and four dVAR type
forecasting systems based on differenced data 259
11.3 Model specification and forecast accuracy 267
11.3.1 Forecast errors of stylised inflation models 268
11.3.2 Revisiting empirical models of Norwegian inflation 273
11.3.3 Forecast comparisons 276
11.4 Summary and conclusions 279
Appendix 281
A.1 The Lucas critique 281
A.2 Solving and estimating rational expectations models 282
A.2.1 Repeated substitution 282
A.2.2 Undetermined coefficients 285
A.2.3 Factorization 288
A.2.4 Estimation 290
A.2.5 Does the MA(1) process prove that the forward
solution applies? 292
A.3 Calculation of interim multipliers in a linear dynamic
model: a general exposition 292
A.3.1 An example 295
Bibliography 303
Author Index 327
Subject Index 333