MCNK Modelling

Multi-Country New Keynesian (MCNK) modelling provides a general framework for the structural analysis of multi-country interactions. The MCNK model itself is the multi-country version of the standard New Keynesian model that measures the effects of macroeconomic fluctuations resulting from exogenous national or global shocks to demand, supply or monetary policy.

This multi-country rational expectations model (similar to those used within the DSGE literature) is constructed using a GVAR approach as shown in Dees, Pesaran, Smith and Smith (DPSS, 2013). The approach involves estimating a set of country-specific rational expectations models and then combining them to solve the system as a whole. Such a model can be used to identify the contribution of domestic and international demand, supply, and monetary policy shocks to business cycle fluctuations. Each country model has the standard three equation structure of a Phillips curve, IS curve and Taylor rule plus an exchange rate equation, with the addition of the price of oil, and the US providing the numeraire.

In constructing a model of this type it is necessary to be cautious with regard to the assumptions made about exchange rates, particularly the treatment of the numeraire, and the patterns of cross country error spillover effects. To obtain a determinate solution and theoretically consistent results, it is also important that a priori sign and stability restrictions predicted by the theory are imposed on the parameters of the country-specific models. Hence, the individual country-specific equations are estimated by the inequality constrained instrumental variables method. As these type of models work with variables measured as deviations from their steady states, a further issue involves the measurement of the steady states. In DPSS these are estimated as long-horizon forecasts from a reduced-form cointegrating global VAR.

A Matlab program with a flexible Excel interface that can be used to replicate the MCNK model in DPSS, can be found here.