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Is the New Keynesian IS curve structural?

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  • Stracca, Livio

Abstract

There is already a small literature emphasising the empirical failure of the New Keynesian IS curve, but it is not yet known if this failure reflects empirical problems associated with small samples or is rather a structural weakness of the underlying model. To address this question, in this paper I estimate the New Keynesian IS curve for output and consumption and several possible extensions on panel data from 22 OECD countries over 40 years of data. I also evaluate whether the key parameters of the IS curve change according to countries' economic and financial structure. The main finding is that output and consumption are mainly forward looking, and this is a very robust feature of the data. At the same time, I find little evidence in favour of the traditional specification where the real interest rate enters with a negative sign due to intertemporal substitution; on the contrary, it is typically either insignificant or wrongly signed. Overall, I conclude that the New Keynesian IS curve, at least in its most common formulations, is not structural and is overwhelmingly rejected by the data. JEL Classification: E21, E44, E52

Suggested Citation

  • Stracca, Livio, 2010. "Is the New Keynesian IS curve structural?," Working Paper Series 1236, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20101236
    Note: 335958
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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1236.pdf
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    References listed on IDEAS

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    Cited by:

    1. Qazi Haque & Leandro M. Magnusson, 2020. "Identification robust empirical evidence on the Euler equation in open economies," Economics Discussion / Working Papers 20-01, The University of Western Australia, Department of Economics.
    2. Jan Willem van den End & Paul Konietschke & Anna Samarina & Irina M. Stanga, 2020. "Macroeconomic reversal rate: evidence from a nonlinear IS-curve," Working Papers 684, DNB.
    3. Antonio Paradiso & Saten Kumar & B. Bhaskara Rao, 2013. "A New Keynesian IS curve for Australia: is it forward looking or backward looking?," Applied Economics, Taylor & Francis Journals, vol. 45(26), pages 3691-3700, September.
    4. Niehof, Britta & Hayo, Bernd, 2014. "Analysis of Monetary Policy Responses after Financial Market Crises in a Continuous Time New Keynesian Model," VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100410, Verein für Socialpolitik / German Economic Association.
    5. Manopimoke, Pym, 2019. "The Output Euler Equation And Real Interest Rate Regimes," Macroeconomic Dynamics, Cambridge University Press, vol. 23(1), pages 420-447, January.
    6. Pym Manopimoke, 2016. "The Output Euler Equation and Real Interest Rate Regimes," PIER Discussion Papers 33, Puey Ungphakorn Institute for Economic Research.
    7. Anari, Ali & Kolari, James, 2016. "Dynamics of interest and inflation rates," Journal of Empirical Finance, Elsevier, vol. 39(PA), pages 129-144.
    8. Hawkins, Raymond J. & Nguyen, Chau N., 2017. "Macroeconomic dynamics and the IS puzzle," Economics Discussion Papers 2017-20, Kiel Institute for the World Economy (IfW Kiel).
    9. Anari, Ali & Kolari, James, 2019. "The Fisher puzzle, real rate anomaly, and Wicksell effect," Journal of Empirical Finance, Elsevier, vol. 52(C), pages 128-148.
    10. Qazi Haque & Leandro M. Magnusson, 2023. "Identification Robust Empirical Evidence on the Open Economy IS‐Curve," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 85(2), pages 345-372, April.
    11. Patrik Kupkovic, 2020. "R-star in Transition Economies: Evidence from Slovakia," Working and Discussion Papers WP 3/2020, Research Department, National Bank of Slovakia.
    12. Kortelainen, Mika & Paloviita, Maritta & Viren, Matti, 2011. "Observed inflation forecasts and the new Keynesian macro model," Economics Letters, Elsevier, vol. 112(1), pages 88-90, July.
    13. Anna Florio, 2013. "The Implied Consumer Euler Rate: What Role for Financial Frictions?," CESifo Economic Studies, CESifo Group, vol. 59(4), pages 650-675, December.
    14. Heinrichs, Katrin, 2016. "German Consumption Inequality. An evaluation with a focus on the financial crisis," VfS Annual Conference 2016 (Augsburg): Demographic Change 145891, Verein für Socialpolitik / German Economic Association.

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    More about this item

    Keywords

    instrumental variables; IS Curve; new Keynesian model; Panel data;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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