Acta Universitatis Danubius. Œconomica, Vol 12, No 5 (2016)

A Bayesian Approach for the Analysis of Macroeconomic Dynamic in Case of Emerging Countries-Monetary and Fiscal Policy Model

Georgiana-Alina Ionita¹

Abstract:The paper proposes the analysis of the main drivers of the economic growth in Central and Eastern Europe, in three emerging countries: Czech Republic, Hungary and Poland, with a development stage similar with that of Romania. Given the vulnerabilities of the Central and Eastern Europe region at the beginning and during the recent global economic and financial crisis, there is an increased interest to identify the models that can describe the principalcharacteristics of the Central and Eastern Europe macroeconomic variables: gross domestic product, investment, wages and salaries, inflation, hours worked, consumption and themonetary variable- interest rate. Moreover, another scope is to analyze the frictions that describe the evolution of the seven data series, as the stochastic dynamic of the macroeconomic model is driven by orthogonal structural shocks.

Keywords:monetary; policy; frictions; shocks

JEL Classification: C01; D50; B22; C4.

1. Introduction

I have proposed to analyze in the current thesis the degree in which the model responses to the requests of the Central and Eastern Europe economies, based on a study completed for the following countries: Poland, Hungary and Czech Republic. In this purpose I have used a Bayesian approach for the estimation of this forward-looking model, in a general equilibrium framework.

The current model is not a simple monetary policy model, involving also the fiscal policy, so it can be analyzed taking into account the policy shocks involved: price and interest rate shocks (as monetary policy shocks) and also the exogenous spending shock (which includes together with net exports also the government spending, instrument of the fiscal policy).

So, the model which is an improvement and a simplified version of the one proposed by the authors Frank Smets and RafWouters in 2003 in the article “An Estimated Stochastic Dynamic General Equilibrium Model for the Euro Area has the purpose to analyze the main drivers of the economic growth, putting an eye on the frictions of these four economies (seven frictions- reduced to the number of the seven observed variables).

As a result, the research proposes an overview of the dynamic of monetary policy that should be conducted in the face of multiple sources of uncertainty, including model and parameter uncertainty as well as uncertainty about future shocks.

2. The Non-Linear Model

2.1. Producers

_{The product with destination of final consumption, ,}is composed of good for intermediate consumption, that are bought by final good producers, grouped into and sold in a perfectly competitive market.

They maximize the profit obtained, as per maximization function:

Max , s.t. ( ),

, are the prices of goods for final consumption and for intermediate consumption and G is a function having the characteristic of being strictly concave on one hand and being an increasing function on the other hand, with the property: G(1)=1.

istheprice mark-up shock, and follows and exogenous ARMA processln .

2.2. Intermediate Goods Producers

The producers of goods with the destination of intermediate consumption follow the technology equation:

Y (i)= - , represents capital in services form, represents the input of labor, while is a fixed cost.

represents the labor growth rate and represents the shock of the productivity factor and is defined as:

ln .

The profit of any firm from the economy follows the following equation: - , represents nominal wage or salary rate and represents the capital rental rate.

The model assumes that firms are able to adjust prices used with probability 1- in each period.

The resulting price that is optimal is obtained from the following maximization function:

Max (

s.t. _.

represents firms probability of price adjustment, is inflation defined as = is the discount factor for firms,

= and

Theindex of prices obtained has the following equation form:

P =(1- .

2.3. Households

Households in order to maximize utility function are able to choose final consumption , the number of working hours , acquisition of bonds _,capital investment and capital utilization _.The utility function is as follows: , related to the following equation of the budget:

Capital at moment “t” has the following form: ,

represents the stochastic premiumresulted frominvestment in bonds, follows the stochastic process: ln = _,

where, has the significance ofrate of depreciation, S(.) is a function for quantifying the cost adjusting, with S( )=0, S’( )=0, S’’(.)>0. illustrates the shock of investment component and is described by the equation: ln = . represents taxes, while represents the dividends for distribution.

2.4. Intermediate labor and labor packers

Households provide their labor forthe intermediate labor union, the labor provided having the following form: . (16)

Labor packers are those who acquire labor from unions and distribute the labor to producers of intermediary goods. Their maximization profit function has the following form:

Max , s.t. ( )

,where and represent the price of total and for intermediary labor services , while H is a function strictly concave , which follows H(1)=1 and is increasing.

is an exogenous shocks of wages mark-up, _{and has the form of an} ARMA process:

From the first order conditions of the labor packers, we obtain:

.

Combining this condition with the zero profit condition we obtain an expression for the wage cost for the intermediate goods producers:

, where is defined as an ARMA process:

ln = .

The dividends that are received by households from labor unions are included in the constraint of budget for households:

In case of unions there are also nominal rigidities as proposed by Calvo (1983), more precisely wages being adjusted with the probability of 1- .

In case of unions who readjust wages, the optimization rule consists of choosing a wage in order to maximize subsequent wage income in case when unions keep this fixed wage.

The expression of aggregate wageobtained is:

.

2.5. Monetary policy and government budget constraint

The interest rate established by central bank by taking into account the deviation of output and inflation from the targeted levels is as follows:

.

is the value of nominal interest rate at steady-state and is the natural gross domestic product.

The parameter represents the interest ratesmoothness, while the definition of the shock of monetary policy, , is: .

The constraint of government budget is described as follow : . represents the nominal lump-sum taxes and the government spending in relation with the steady-state output follows the process:

.

3. The Linearized Model

The aggregate constraint for the linearized model is described as follows: (1) ,

The interpretation of the resource constraint is that gross domestic product ( ) is absorbed by investment ( ), consumption ( ), capital utilization costs (expressed in relation to the capital utilization rate ( ) and the exogenous spending shock ( )). In addition, is the state-state share of consumption in output and is equal to , where and are the steady-state exogenous spending-output ratio and investment-output ratio.

In addition,