INVESTIGATING THE ROLE OF MONEY IN THE IDENTIFICATION OF MONETARY POLICY BEHAVIOR: A BAYESIAN DSGE PERSPECTIVE

Abstract

This paper estimates an enriched version of the mainstream medium-scale dynamic stochastic general equilibrium model, which features nonseparability between consumption and real money balances in utility and a systematic response of the policy rate to money growth. Estimation results show that money is a significant factor in the monetary policy rule. As a consequence, econometric analysis that omits money from Taylor rules may lead to biased estimates of the model parameters. In contrast to earlier studies that rely on small-scale models, the paper stresses the merits of using a sufficiently rich model. First, it delivers different results, such as the role of nonseparability between consumption and money in utility. Second, the rich dynamics embedded in the model allow us to explore the responses of a larger set of macroeconomic variables, making the model more informative on the effects of shocks and more useful for understanding the sources of business cycles. Third and most importantly, it reveals the possible pitfalls of relying on small-scale models when studying money’s role in business cycles.