Econometric Models of the Euro-area Central Banks

Econometric Models of the Euro-area Central Banks

Edited by Gabriel Fagan and Julian Morgan

This book provides a description of the main macroeconomic models used by the European Central Bank and the euro area national central banks (Eurosystem). These models are used to help prepare economic projections and scenario analysis for individual countries and the euro area as a whole.

Chapter 3: EDGE: the Bank of Finland's macroeconomic model of the euro area

Mika Kortelainen

Subjects: economics and finance, econometrics, money and banking


3. EDGE: the Bank of Finland’s macroeconomic model of the euro area Mika Kortelainen 1 INTRODUCTION The euro area Dynamic General Equilibrium (EDGE) model is built and used to illustrate the analysis of monetary policy credibility in Europe. The underlying principles of the model are the inclusion of micro-foundations through the optimization behaviour of representative agents and the explicit treatment of expectations. We usually use the assumption of rational expectations, but the model can be used to analyse heterogeneous expectations, too, for example in the context of less than perfect monetary policy credibility. A simplification which has been made in constructing the model is that the derivation of the equations is done under the certainty equivalence assumption, with some risk premia added later ad hoc in the arbitrage equations in the model. The model has nominal rigidities in the short run, which allow monetary policy to have real effects. Hence the model can be characterized as following the New Keynesian approach and it displays many Keynesian short-run properties, but the long run is quite neoclassical, at least in the rational expectations mode, owing to forwardlooking expectations and long-run market clearing. The current version of the EDGE model is calibrated to publicly available euro-area data. EDGE is currently used in policy analysis, but can equally be applied to forecasting. The novel feature of the EDGE model is that it can be used to illustrate the analysis of monetary policy credibility in the face of heterogeneous expectations. Since the model...

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