Toward a Modern Macroeconomic Model Usable for Policy Analysis

47 Pages Posted: 26 Jul 2010 Last revised: 7 Jul 2022

See all articles by Eric M. Leeper

Eric M. Leeper

University of Virginia ; Indiana University at Bloomington - Department of Economics; National Bureau of Economic Research (NBER); George Mason University - Mercatus Center

Christopher A. Sims

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: June 1994

Abstract

This paper presents a macroeconomic model that is both a completely specified dynamic general equilibrium model and a probabilistic model for time series data. We view the model as a potential competitor to existing ISLM-based models that continue to be used for actual policy analysis. Our approach is also an alternative to recent efforts to calibrate real business cycle models. In contrast to these existing models, the one we present embodies all the following important characteristics: i) It generates a complete multivariate stochastic process model for the data it aims to explain, and the full specification is used in the maximum likelihood estimation of the model; ii) It integrates modeling of nominal variables -- money stock, price level, wage level, and nominal interest rate -- with modeling real variables; iii) It contains a Keynesian investment function, breaking the tight relationship of the return on investment with the capital-output ratio; iv) It treats both monetary and fiscal policy explicitly; v) It is based on dynamic optimizing behavior of the private agents in the model. Flexible-price and sticky-price versions of the model are estimated and their fits are evaluated relative to a naive model of no-change in the variables and to an unrestricted VAR. The paper displays the model's implications for the dynamic responses to structural shocks, including policy shocks, and evaluates the relative importance of various shocks for determining economic fluctuations.

Suggested Citation

Leeper, Eric Michael and Sims, Christopher A., Toward a Modern Macroeconomic Model Usable for Policy Analysis (June 1994). NBER Working Paper No. w4761, Available at SSRN: https://ssrn.com/abstract=1647514

Eric Michael Leeper (Contact Author)

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Christopher A. Sims

Princeton University - Department of Economics ( email )

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