Essays on Structural Changes, US Business Cycles and Monetary Policy

Abstract

In this thesis I study a major structural change in the US economy, namely, the consequences of the Great Moderation on the US economy and the operation of monetary policy. My first chapter explores a variety of empirical relationships on lead-lag properties of the US business cycle and how these relationships have changed since the onset of the Great Moderation. We emphasize four major changes in lead-lag properties. Since these relationships serve as a benchmark for many models of the business cycle, we examine if a variety of models can account for these changes. We find that they cannot. My second chapter provides an explanation for the first property in my first chapter, that the real interest rate switched from negatively leading the US business cycle to positively lagging. The explanation rests on the fact that uncertainty about the current state of the economy has become less severe since the onset of the Great Moderation. This allows policymakers to set monetary policy closer to their rule-based policy prescription under no uncertainty and reduce unintended monetary induced fluctuations. My third chapter explores business cycle asymmetry prior to and after the Great Moderation. I show that the business cycle has become more asymmetric since the onset of the Great Moderation with booms becoming smaller and busts staying relatively the same. I highlight that this type of asymmetry is consistent with a class of models which feature occasionally binding collateral constraints. My fourth chapter is a contribution to New Keynesian (NK) models. In a standard NK model, monetary policy operates through the real interest rate channel. This channel has recently drawn some criticism when the model is extended to include capital accumulation. In this setting it is possible for the real interest rate to fall in response to a positive monetary policy shock, contradicting the intuition of the real interest rate channel. We show that result vanishes when frictions on the flow of investment are present, as in modern NK models. Under this framework the response of the real interest rate is always the same as the monetary policy shock.