An Estimated Stochastic Dynamic General Equilibrium Model of the Euro Area

TLDR

The study develops and estimates a stochastic dynamic general equilibrium model for the euro area, incorporating sticky prices and wages and ten orthogonal structural shocks to examine their impact on business‑cycle fluctuations. The model features habit formation, capital‑adjustment costs, variable capacity utilisation, and is estimated with Bayesian methods using seven macro‑economic variables (GDP, consumption, investment, prices, real wages, employment, nominal interest rate). The estimated model is used to analyze the output gap, defined as the difference between actual and model‑based potential output, and the real interest rate.

Abstract

This paper develops and estimates a stochastic dynamic general equilibrium (SDGE) model with sticky prices and wages for the euro area. The model incorporates various other features such as habit formation, costs of adjustment in capital accumulation and variable capacity utilisation. It is estimated with Bayesian techniques using seven key macro-economic variables: GDP, consumption, investment, prices, real wages, employment and the nominal interest rate. The introduction of ten orthogonal structural shocks (including productivity, labour supply, investment, preference, cost-push and monetary policy shocks) allow for an empirical investigation of the effects of such shocks and of their contribution to business cycle fluctuations in the euro area. Using the estimated model, the paper also analyses the output (real interest rate) gap, defined as the difference between the actual and model-based potential output (real interest rate).