4.4 Calibration
4.4.1 Parameterization
Starting with the relative risk aversion coefficient, it is considered that economic agents in the developing economies are more risk averse in nature than in the advanced economies. Gali (2005) showed that the value of this coefficient can vary from 1 to 5. Discount factor, the benchmark of forward looking behaviour, is taken as 0.99 and 0.98 for developed and developing economies respectively, in order to keep the consistency with real interest rate differential. In the case of inverse of the Frisch elasticity of labour supply, the value is taken from Gali and Blanchard (2007) for developed countries. For developing economies, the elasticity of employment is measured by Goldberg (2010) as 0.15-0.17 and following this, the baseline value is
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taken as 6. Following Brooks (2010), the steady state share of food production in total output for developing countries (0.14) is taken substantially larger than the developed countries (0.05).
The share of food consumption in the aggregate consumption basket varies between 50-65% for East and South-East Asian developing countries and therefore, it is taken as 0.57 for these economies (Hoyos & Lessem, 2008). As the evidence suggests in Seale, et al., (2003), the share of food consumption in aggregate consumption expenditure is significantly lower in developed countries, so, it is set at 0.16. However, as a certain level of calorie is required for economic agents to survive irrespective of the economy, the level of subsistence consumption remains the same for both advanced and developing economies and is taken as 0.38 following Gollin et al., (2004). Regarding the elasticity of substitution between food and non-food consumption, it depends on the per capita income of households. Since, developed countries have higher per-capita income and developing countries are on their way to catching up with this, it is plausible to find a more elastic nature of substitutability in consumption for advanced countries than developing group and accordingly, value of the parameter is chosen as 1.5 and 1.2 respectively52.
In case of the labour aggregator, the parameters of labour share and elasticity of labour substitution can be chosen freely from their specified parametric range. It is assumed that due to land attachment and ethnic background, households of developing economies are involved more to work in the food sector than that of advanced countries. Further, a greater integrity of the households with work schedule
52 See Masao Ogaki (1992).
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across the food and non-food sectors in developing countries entails greater physical constraint for them to reschedule it when compared to the households of advanced countries.
Table 4.4A: Parametric Configuration for Advanced Economy
Parameters Values
Risk aversion coefficient
2
Inverse of the elasticity of labour supply
5
Discount Factor
0.99
0.01 Share of Food production in Aggregate output at steady state 0.05
Share of food in consumption 0.16
Elasticity of substitution between food to non-food consumption
1.5
Share of labour in food sector
0.06 Elasticity of substitution of labour supply between food and non-food sector
0.75 Subsistence level of food consumption
0.38 Intra-sector elasticity of substitution for food sector
11 Intra-sector elasticity of substitution for non-food sector
15
Degree of price stickiness in food sector 0.25
Degree of price stickiness in non-food sector
0.67 Steady state labour allocation for food sector in the aggregate labour
0.08 Steady state labour allocation for non-food sector in the aggregate labour
0.92 Measure of decreasing returns in food sector production
0.36 Measure of decreasing returns in non-food sector production
0.55
Coefficient of inflation stabilisation 1.5
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Table 4.4B: Parametric Configuration for Developing Economy
Parameters Values
Risk aversion coefficient
2.2
Inverse of the elasticity of labour supply
6
Discount Factor
0.98
0.02 Share of Food production in Aggregate output at steady state 0.14
Share of food in consumption 0.57
Elasticity of substitution between food to non-food consumption
1.2
Share of labour in food sector
0.4 Elasticity of substitution of labour supply between food and non-food sector
0.15
Subsistence level of food consumption 0.38
Intra-sector elasticity of substitution for food sector
7 Intra-sector elasticity of substitution for non-food sector 10
Degree of price stickiness in food sector 0.2
Degree of price stickiness in non-food sector 0.65
Steady state labour allocation for food sector in the aggregate labour
0.42 Steady state labour allocation for non-food sector in the aggregate labour
0.58 Measure of decreasing returns in food sector production
0.2 Measure of decreasing returns in non-food sector production
0.33
Coefficient of inflation stabilisation 1.2
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Table 4.4C: Parameterization of Shock Structure
Shock Parameters Values for Advanced Economy Source Values for Developing Economy Source
0.947 Ireland, 2004 0.78 Peiris & Saxegaard, 2007 0.95 Ireland, 2004 0.85 Annicchiarico, et al., 2008
0.962 - 0.9 Ahmad, et al., 2012
0.7 - 0.5 Peiris & Saxegaard, 2007
0.0405 Ireland, 2004 0.065 Peiris & Saxegaard, 2007
0.014 - 0.022 Annicchiarico, et al., 2008
0.012 Ireland, 2004 0.018 Ahmad, et al., 2012
0.0031 Ireland, 2004 0.013 Peiris & Saxegaard, 2007
This underlines the fact that substitutability of labour between the two sectors is more inelastic for households of developing countries than for advanced ones. Keeping such conjecture in place, the exact values of these parameters are chosen from computational exercise. The values of labour share for the food sector are taken as 0.4 for developing and 0.06 for advanced country while the values of inter-sector elasticity of labour substitution are chosen as 0.15 and 0.75 respectively. Overall, these two parameters of labour share for food and elasticity of labour substitution govern the movement of labour supply within economy.
The measure of decreasing returns for the food and non-food sector, for both economies, is picked up from Gollin et al., (2004). The difference in choice reflects greater share of labour for developing economies. The intra-sector elasticity of substitution for both sectors is chosen with presumption that intermediate goods producing firms of advanced economies face more competition and have less market power than that of developing economics. The values are taken to keep a clear demarcation of mark up between the two economies. Moreover, due to a lack of close substitutes of food compared with non-food, monopolistic power can indulge
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the firms to charge a greater mark up in the food sector than that of the non-food sector. Considering the degree of price stickiness for the advanced group, the food sector exhibits substantially less stickiness of price compared with the non-food and therefore, the values are chosen for developed countries to capture a reasonable difference in price stickiness. Using historical commodity prices collected from different markets of developing countries (the monthly dataset during the period of January, 1960 to May, 2011, Source: Pink data, World Bank), the stickiness of prices have been measured categorically for the food and non-food sectors following the
Indirect Estimation of Price Duration under Frequency Approach as in Kovanen
(2006) and Morandey and Tejada (2008). It is found that food price, on an average, lasts for approximately a quarter while the price of non-food item remains unchanged for more than three quarters53. Following this empirical observation and
the estimate provided by Gabriel et al., (2011) with reference to the formal and informal sector, values for price stickiness indices for the food and non-food sector are chosen.
The coefficients of inflation and output gap for monetary policy rule are considered as suggested by Gali (2005). However, following the findings of previous chapter, a reasonable difference in the policy rule between advanced and developing economies is portrayed by parameterization. To fulfil the condition of determinacy, active policy is allowed in the baseline model of developing economy but lack of inflation targeting has been included by keeping a difference in the size of inflation coefficient in policy rule in contrast to advanced countries. However, relative to inflation, greater priority is attached on output stabilisation for developing countries
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as economic growth is the prime objective for them compared to their advanced counterpart. Finally, the shock process is structured based on the work of Ireland (2004) for advanced countries and Peiris & Saxegaard, (2007), Annicchiarico, et al., (2008), Ahmad, et al., (2012) for developing economies.