874 Macroeconometric Modeling for Policy
which becomes a natural rate of unemployment, independent of inflation subject
to dynamic homogeneityα12,0+β 18 =1.
However, the claim thatu
phil
t represents an asymptotically stable solution must
be stated with some care. As shown in, e.g., Bårdsen and Nymoen (2003),γ 11 =0is
a necessary but not a sufficient condition. The sufficient conditions includeγ 22 = 0
in addition toγ 11 =0 and, instead of equilibrium correction in wages and prices,
dynamic stability requires equilibrium correction in the unemployment equation
or in a functionally equivalent part of the model.
The result that the steady-state level of unemployment is generally undeter-
mined by the wage–price sub-model is a strong case for building larger systems
of equations, even if the main objective is to model inflation. Conversely, in
general, no inconsistencies or issues about overdetermination arise from enlarg-
ing the wage/price-setting equations with a separate equation for the rate of
unemployment, where demand-side variables may enter.
Looking ahead, in section 17.4.3 we show how the specification of the sup-
ply side, either as a Phillips curve model (PCM) or as an incomplete competition
model (ICM) given by equations (17.28) and (17.29) above, gains economic sig-
nificance though the implications of the chosen specification for optimal interest
rate-setting.
17.2.6.5 Implementation in the Norwegian aggregate model
We have implemented the above model of the supply side in our quarterly model
of the Norwegian economy, called the Norwegian aggregate model (NAM).^10
The estimated versions of (17.30) are given in section 17.3.1, equations (17.38)
and (17.39). The equilibrium correction terms are defined consistently with the
two long-run equations (17.25) and (17.26). For example, δ 12 = 0,ζ = 0.7,
δ 15 =0.1 andδ 16 =1 are taken as known parameters from the cointegration
analysis documented in Bårdsenet al.(2005, Ch. 9.2). With this parameteriza-
tion, the estimated equilibrium correction coefficientsγˆ 11 andγˆ 22 are jointly and
individually significant (thet-values are 8.6 and 3.8).
The estimated short-run dynamics can also be interpreted in the light of the
theoretical model (17.30). For example, the estimated wage equation (17.39) shows
thataˆ 12 ( 1 )=1, saying that dynamic homogeneity with respect to consumer price
is a valid restriction on wage dynamics in the wage equation. Identification of
the short-run wage price model is in terms of zero-restrictions on the GDP growth
variable in thewtequation, and on the change in the rate of unemployment in
theptequation. There are overidentifying restrictions as well though.
17.3 Building a model for monetary policy analysis
Monetary policy now plays a dominant role in stabilization policy in general and
in managing inflation in particular. As economists have recognized for a long
time, inflation is a many-faceted phenomenon. In particular, in open economies,
a proper understanding of the inflation mechanism requires the construction of a