 # Gali et al. (2007) - Issue with market clearing condition

Dear MBB-Team,

we are currently working on the Gali et al. (2007) model using your replication code as basis.
However, we are wondering whether the market clearing condition in the replication as well as in the paper are correct. We believe that the log linearized form shoud be:

y = gamma_cc + gamma_ii + gamma_g*g,

i.e. gamma_g is missing.

Kind regards,
Yannik

Dear Yannik,

the notation in this equation is somewhat misleading.

After log-linearization, the market clearing condition should read:
y_tY = c_tC + i_tI + g_tG,
where small letters denote log-deviations of the variables from their steady state, and capital letters denote the steady state values of the corresponding variable.
So, after dividing by Y:
y_t = c_tC/Y + i_tI/Y + g_t*G/Y.

As it holds that gamma_c==C/Y and gamma_i==I/Y, in a consistent notation there should be a gamma_g==G/Y in the equation. However, on page 241 of the paper the authors define: g_t to be (G_t-G)/Y_t, i.e. the fraction G/Y is already included in the definition of g_t.

Best,
Felix

Dear Felix,

thank you very much for your fast reply. As a next step, we try to add monetary policy to the paper.

Therefore, we add the following equations:
r = phi_pipi + e_mp; Taylor Rule depening on Inflation
e_mp = rho_emp
e_mp(-1)+eta_r; AR(1) shock process in the taylor rule

Furthermore, we adapt equation C(6) on the left side as follows:
c - theta_n*n + r/sigma_bar

As a result, however, we receive unlogical results: I.e. investments are increasing after an increase in the interest rate…

Did we forget something. How would the could have to look like if adding monetary policy and considering a monetary policy shock?

Best regards,
Yannik