Topic: News Shocks and the Term Structure of Interest Rates: Lessons for DSGE Models

Time: June 20, 2-3:30pm

Location: Guanghua Building 2.Room 216

Speaker: Christopher Otrok (website:http://web.missouri.edu/~otrokc/)

Affiliation: University of Missouri

Abstract: News shocks about future increases in Total Factor Productivity (TFP) lead to a large and persistent drop in inflation and the Federal Funds rate while driving up the slope of the term structure of interest rates (Kurmann and Otrok, 2012). In this paper, we first show that a benchmark medium-scale DSGE model with nominal rigidities parameterized to standard values is unable to replicate these dynamics. We then estimate the model with a limited-information procedure that is designed to match as closely as possible the impulse responses of key macroeconomic aggregates, inflation and the term structure to TFP news shocks. This empirical approach, coupled with a sequence of model variations, delivers a set of lessons on reconciling the benchmark model with the empirical news impulse responses. The main lesson is that while the model can be modified to improve the fit along the TFP news dimension, these modifications come at the cost of severely deteriorating the model's response to other prominent shocks, such as a monetary policy shock.

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