Can we examine which structural shocks connect to BCA wedges numerically?
- I simulate a calibrated model (calibrated to economy A) with a monetary policy shock (u_t). Here, u_t drives most of the variation in the inflation rate, for example.
- I obtain simulated data on consumption, output, labor, inflation rate, and interest rate.
- I perform BCA using the simulated data.
- I find that the Taylor wedge drives most of the variations in the inflation rate.
From 1 and 4, can I say that monetary policy shocks manifest as Taylor wedges?
Yes, that exercise should be valid, at least in a linearized model where shock contributions are additive. But I don’t understand point 4. If your model only contains a monetary policy shock, what else could explain a wedge?
Yeah, the non-BCA model contains only monetary policy shock. But it could manifest as any of the individual wedges in the BCA model, right? In this example, maybe it is quite easy to see that monetary policy shock in the non-BCA model will manifest as Taylor rule wedge in BCA model.
But, I can consider, say, structural gold price shocks for economy A. And then I ask which of the wedges in the BCA model do they connect to more strongly? Productivity wedge or Investment wedge? We don’t know, I guess. So I simulate data using a calibrated model for economy A (with only gold price shock), and see how it manifests in the BCA model.
If gold price shocks strongly drive output in the non-BCA model, and investment wedge strongly drives output in the BCA model, then I can say gold price shocks connect to investment wedge rather than say productivity wedge for economy A, yeah?
Of course, I am assuming the non-BCA model is correct, and gold price shocks strongly drive output in that model, which may not be the case. But is such an experiment valid if these conditions are satisfied?