Still about a model that is similar to Smets and Wouters (2007) and the measurement equations. It is said that “even if the data is demeaned, the constant terms should be included, because the allocation from the flexible price economy cannot be attained in an economy with frictions”. I don’t quite understand what this means. To me it seems that the measurement equations are only written in terms of the sticky price economy. So how is the flexible price economy involved here?
Where does the statement you reference come from?
Thanks for your reply.
It is from Drautzburg and Uhlig (2015) appendix page XXXIII. I think they are mainly refering to the last three equations. Drautzburg Uhlig appendix.pdf (612.0 KB)
But I think Smets and Wouters (2007) also has kept those constant terms in the code, the “constelab” in the equation for labor for instance. That’s what I am wondering about.
SW 2007 did not demean the data. Rather they imposed cointegration between the respective series. Thus, the growth rates are imposed to be the same.