Q2. What are the future works in this paper?
Their analysis is based on a prototype economy that underlies a large class of models used to study the business cycle and the effects of monetary policy. The authors hope that their findings will provide useful information to researchers constructing detailed models with explicit frictions to analyze the business cycle and monetary policy. The authors leave, however, such investigation for future research. The authors have also discussed how the effects of these frictions on inflation and the nominal interest rate can be understood through a pricing function in their prototype economy.
Q3. What is the effect of leaving out the asset market wedge?
when the authors leave out the asset market wedge, the nominal interest rate becomes strongly countercyclical with no apparent lead-lag structure.
Q4. What does leaving out the labor wedge do?
Leaving out the labor wedge also deteriorates the observed dynamics, but somewhat preserves its general pattern, leaving the interest rate negatively correlated at leads and positively correlated at most lags.
Q5. What is the reason for the high volatility of the asset market wedge?
The high volatility of the asset market wedge reflects the well-known failure of Euler equations with power utility functions to match asset prices (e.g., Hansen and Singleton, 1983).
Q6. What are the tions that express the deviations of log yt, log l?
tions that express the deviations of (log yt, log lt, log xt, log ct, log pt, Rt) from steady state as linear functions of the deviations of the state vector (ωt, log pt−1, Rt−1, log kt) from steady state.
Q7. What are the two wedges that are necessary for generating the observed lead-lag pattern?
the efficiency and asset market wedges are both necessary, and to some extent also sufficient, for generating the observed lead-lag pattern of the two nominal variables.
Q8. What are the two wedges that should be included in the model?
Their findings suggest that such models should, first and foremost, include frictions that manifest themselves as efficiency and asset market wedges.
Q9. How do the authors compute the labor wedge component of the data?
Starting from p−1, R−1, and k0 for 1959.Q1, these decision rules and pricing functions are used, together with ωdt (the vector of realized wedges obtained using the procedure of Section 4.3), to compute the labor wedge component of the data.
Q10. What are the key frictions behind the observed dynamics of inflation and the nominal interest rate?
To summarize, the main finding of the decomposition is that from the perspective of their prototype economy, the key frictions behind the observed dynamics of inflation and the nominal interest rate over the business cycle are those that are equivalent to efficiency and asset market wedges.
Q11. What are the three steps used to compute the equilibrium decision rules and pricing functions of the prototype economy?
And third, the authors use the equilibrium decision rules and pricing functions of the prototype economy to back out the realized wedges from the data.
Q12. What are the wedges of the prototype economy?
In a working-paper version of this paper (Sustek, 2009) the authors also show that a model of inflation dynamics based on capacity utilization and energy price shocks studied by Finn (1996) is equivalent to the prototype model with efficiency wedges.
Q13. What does Henriksen et al. (2008) show?
Henriksen et al. (2008) show that a business cycle model in which the central bank follows a Taylor rule, and in which the only impulses are TFP shocks, also cannot account for such a feature of the data.
Q14. What is the procedure used to isolate the movements in the endogenous variables of the model?
This procedure isolates the movements in the endogenous variables of the model (and thus also in the data, as movements in all six wedges exactly reproduce the data) due to the distortionary effects of the labor wedge alone.
Q15. What is the reason for the strong positive correlation of the asset market wedge with output?
The strong positive correlation of the asset market wedge with output documented here, however, reveals systematic failure of the standard Euler equation for bonds to account for the movements in the risk-free rate over the business cycle.
Q16. What is the importance of the wedges for generating the observed dynamics of the nominal interest rate?
As the next section shows, the efficiency and asset market wedges are crucial for generating the observed dynamics of the nominal interest rate and inflation over the business cycle.
Q17. How is the search for the maximum of the likelihood function implemented?
The search for the maximum of the likelihood function is implemented using simulated annealing (see Goffe, Ferrier and Rogers, 1994) in order to thoroughly explore the surface of the objective function.
Q18. What is the coefficient of correlation between the two wedges?
Here the authors just want to point out that these two wedges are strongly positively correlated with each other, having a coefficient of correlation of 0.53.