Research Methods Endogenous Growth Model

Question: Discuss about the Research Methods for endogenous growth model? Answer: Introduction: The endogenous growth model with the shocks in the monetary policy and imperfect adjustment of prices reflects the term structure interest rates and risky bonds that vary with time. It is seen from the empirical evidence that there are tight linkages in the fluctuation in macroeconomics and bond yields. Predicting the term structure features gets difficult with the help of the macroeconomic models. The endogenous growth model embeds the vertical innovation framework with the Keynesian General Equilibrium framework. The model holds certain remarkable features like recursive preferences of the household, setting of short-term interest rate for targeting the inflation, the decision of the firm regarding production led to growth prospects (Jermann 2013). Taylor rule is followed to find the link between the asset price and monetary policy. In this paper, the main highlights are the critical analysis of equity premium by the pricing models, production asset models and long run risk emerged in the production economies. Term structure of interest rate is an important consideration of study. Critical Analysis on the linkages between the term structure of interest rate and the monetary policy: The benchmark model considers important building blocks and they are households, firms (final goods and intermediate goods), central bank, symmetric equilibrium, bond pricing and equilibrium inflation and shock. The quantitative aspect of the model has been critically analysed. The preference parameters show standard values in the quarterly calibrations. This reflects that there is lower risk in the end. The calibration of the technology panel is made so that is reflects a standard macroeconomic literature (Bansal and Shaliastovich 2012). The price adjustment is done to so that the impulse of the output to the shocks in the monetary policy. The whole process of calibration is done so that it matches the standard situation. The capital adjustment cost parameter of R and D is very small which implies that the economy would be able to utilise the capital stock in the most inexpensive form. The economic growth escalates with the usage of capital (TOMURA 2012). The slope of the yield curv e is hardly influenced by the uncertainty and monetary policy shocks. It has been seen that there was rise in the inflation risk premia with the level of maturity. The investment by the firms is seen to have a negative relation with consumption growth and inflation. With more products in the economy, there will be increase in consumption, which might lead to increase in the inflation in the end. In the short run, the situation is negative. Model is a close representation of the empirical findings (Backus, Foresi and Zin 2014). The low frequency components are removed in order to find the long run correlation. The implication of negative growth and inflation means there is lower benefits derived from the bonds that has longer maturity period. This mainly happens when there is low growth in the end. The agents achieve positive premium when there is lower growth rates. Lower volatilities for the longer period of bonds are present in the data, which is a problem in the common study. The productivity shock and the volatility shock are important in the model. Productivity shock is a very important part for yield of bonds having different maturity. Long-term bonds have lower volatilities so the volatility shock is important. When there is lower consumption, growth then there is the payoff from long maturity bond is more than the short run (Beeler 2012). The main reason for this is the positive autocorrelation of consumption growth. The real yield curve varies it is not always downward sloping there may be exceptions where the curve may be upward rising. The bond returns are forecasted by single factor like forward rates and forward premium. The economic uncertainty fluctuation is derived from the time varying risk bond premia. The real marginal cost is very important concern as this affects the equilibrium inflation. The inflation uncertainty will rise when there is strong uncertainty of shocks. The macroeconomic activity is strongly related to the yield curve. The slope of the curve is an important concern, as this affects the inflation and the economic growth. The R square value is stable suggests that the regression line perfectly fits into the data. During the time of productive shock, inflation is lowered. The monetary authority also tries to reduce the inflation more by reducing the rate of inflation. Low Inflation is beneficial for the nation as this would spurge growth (Zhou and Zhu 2015). When there is strong negative correlation between the inflation and the yield spread then there is reaffirmation of the inflation forecasting regression forecasting. There is strong positive relation between Rand D rate and the spread term. The relationship is further strengthened by the positive productivity shock. Slope of the term curve plays a very important part (Guarda and Jeanfils 2012). A sizable rate of equity premium is generated due to endogenous long run risk. The volatility level intensifies with the presence of the wage rigidities. The term spread forecasts excess return from stocks. This is indeed a good sign for the investors. The model has positive slope coefficient, which is statistically significant. The term premium through the inflation and consumption is impacted by the parameters like the depreciation rates and adjustment costs. Lower rate of depreciation helps in making the consumption to get smoother for the household. The risk is reduced with lower consumption volatility. Risk premia and consumption volatility is reduced with the fall in the depreciation rate in Rand D capital. The negative link of inflation and growth is weakened by the investment in the Rand D and increased curvature. The growth channel plays importance in explaining the average spread of nominal term. The long run risk and endogenous growth is critical in generating long-term negative relation between growth and inflation (Jermann 2013). The positive correlation between consumption growth and inflation gives rise to the downward sloping nominal yield curve. The long-term shock in productivity will generate more wealth for the workers (Jermann and Quadrini 2012). The workers will not be willing save and the entire amount will be expensed. This would however give rise to inflation as the real marginal cost rises. This endogenous productive model is affected by the decision of labour. Inflation risk gives rise to increasing level of maturity due to the positive nominal term premium. Monetary policy plays a crucial role in the determination future inflations and empirical growth with the help of nominal term premium. In the end the risk factors is very important fitting in the interest rate levels. T he yield increases with maturity this lead to higher yield curve (Kung 2015). The lenders demand for the higher rate of interest for the long-term loans for the compensation for the risk that was involved in comparison with the short-term loans. The opposite scenario occurs when there is inverted yield curve. There is probability of recession during inverted yield curve. Conclusion: There is perfect match of the volatilities and means of the nominal bond yields and this helps in representing bond yields exceptionally well. The failure of the expectation hypothesis is also captured. The decision of the firm regarding the investment captures a very inverse relation with consumption growth and inflation. The dynamics of inflation and growth is crucial so rationalised facts in the bond market. The calibration to macroeconomic data helps in appropriate explanation of the model. The rule of monetary policy helps in connecting the aggregate variables and interest rates. A link is generated between the investment and the term structure. The pure production based framework can also explain the average yield curve and failure of the hypothesis expectation. References: Backus, D., Foresi, S. and Zin, S. 2014. Arbitrage Opportunities in Arbitrage-Free Models of Bond Pricing.Journal of Business Economic Statistics, 16(1), p.13. Bansal, R. and Shaliastovich, I. 2012. A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets.Rev. Financ. Stud., 26(1), pp.1-33. Beeler, J. 2012. The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment.CFR, 1(1), pp.141-182. Guarda, P. and Jeanfils, P. 2012.Macro-Financial Linkages. London: Centre for Economic Policy Research. Jermann, U. 2013. A production-based model for the term structure.Journal of Financial Economics, 109(2), pp.293-306. Jermann, U. 2013. The equity premium implied by production.Journal of Financial Economics, 98(2), pp.279-296. Jermann, U. and Quadrini, V. 2012. Erratum: Macroeconomic Effects of Financial Shocks.American Economic Review, 102(2), pp.1186-1186. Kung, H. 2015. Macroeconomic linkages between monetary policy and the term structure of interest rates.Journal of Financial Economics, 115(1), pp.42-57. TOMURA, H. (2012. ENDOGENOUS SELECTION OF PRODUCERS, ASSET PRICES, AND PRODUCTIVITY SLOWDOWN*.Japanese Economic Review, 63(1), pp.104-130. Zhou, G. and Zhu, Y. 2015. Macroeconomic Volatilities and Long-Run Risks of Asset Prices.Management Science, 61(2), pp.413-430.