Palgrave Handbook of Econometrics: Applied Econometrics

Gunnar Bårdsen and Ragnar Nymoen 875

model that separates the internal dynamics of the domestic wage price spiral from
the factors that impinge upon it from outside. The complexity of the real-world
inflation process also means that models which only include one or two dimen-
sions typically fail to characterize the data. Our starting point is therefore that, at
a minimum, foreign and domestic aspects of inflation have to be modeled jointly,
and that the inflationary impetus from the labor market, the battle of markups
between unions and monopolistic firms, needs to be represented in the model.
The last section ended with an example of the econometric specification of a
model of wage- and price-setting that defines an integral part of the NAM model.
Earlier versions of this model have been used to analyze the issues raised by the
introduction of model-based monetary policy in Norway (see Bårdsen, Jansen and
Nymoen, 2002, 2003; Bårdsenet al., 2005). NAM is in use for forecasting as part of
the Normetrics forecasting system.^11 A designated version is operational for stress
testing by the financial stability division at the central bank of Norway.

17.3.1 The model and its transmission mechanisms

In the regime with inflation targeting, the policy instrument in the model is the
money market interest rate, symbolized byRin Figure 17.2 (and throughout this
chapter), with the estimated reaction function reported in equation (17.46).^12
The qualitative transmission mechanisms of the model, from the perspective of
monetary policy analysis, are shown in Figure 17.2. The corresponding quantita-
tive approximate transmission mechanisms are easily worked out with the stylized

Exchange rate

v

Import price

pi

Policy rate

R

Wages (w)

and

prices (p)

Exchange rate Demand channel Labor market Reaction function

channel

Productivity

z

Unemployment

u

GDP

y

Credit

(l – p)

Loan and

bond rate

RL and RB

Figure 17.2 The transmission mechanisms in the model in Table 17.1