ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Dynamic Stochastic General Equilibrium Modelling

In recent years Dynamic Stochastic General Equilibrium models have come to play an increasing role in central banks, as an aid in the formulation of monetary policy (and increasingly after the global crisis, for maintaining financial stability). DSGE models, it is claimed, are less a-theoretic than other widely used models such as VAR, or dynamic factor models. As the models are "structural," they are supposed to be immune to the Lucas Critique, and thus can be "taken to the data" in a meaningful way. However, a major feature of these models is that their theoretical underpinnings lie in what has now come to be called as the New Consensus Macroeconomics. Using the prototype real business cycle model as an illustration, this paper brings out the econometric structure underpinning such models. A detailed analytical critique is also presented together with some promising leads for future research.

Deflation, Devaluation and Employment

For the first time since the 1930s there is an apprehension that, following Japan, the United States and the euro-zone of Europe are likely to enter a state of deflation that entails a vicious circle of falling prices, lower income and fewer employment. To meet the challenge the US Federal Reserve Board has adopted a policy of reducing interest rate to almost zero. This note argues that the Fed policy of almost-zero interest rate tilts the factor-price ratio severely against labour vis-Ã -vis capital. In a regime of zero interest rate the economy would minimise the use of labour, replacing it by capital as far as possible. The professed goal of attaining the 'potential output' that means full employment, inter alia, will be defeated by the very policy that seeks to close the 'output gap'. This note constructs an alternative or additional policy to combat deflation. It also alerts third world countries that America and Europe may resort to competitive devaluation in order to export their deflation to third countries.
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