Monetary Business Cycle Model Research Articles

A monetary business-cycle model with an augmented cash-inadvance constraint, investment tax credit and a government sector: the case of Bulgaria (1999-2022)


 
 
 We modify an otherwise standard business cycle model with a richer government sector, and add an augmented cash-in-advance (CIA) considerations. In particular, the cash in advance constraint of Cole (2020) is extended to include private investment and government consumption, and allows a proportion of total expenditure to be done using credit. Additionally, we allow for the presence of an investment subsidy (“investment tax credit”). This specification is then calibrated to Bulgarian data after the introduction of the currency board (1999-2022), gives a role to money in accentuating economic fluctuations. In particular, the modified CIA constraint pro- duces a mechanism that allows the framework to reproduce better observed variability and correlations among model variables, and those characterizing the labor market in particular.
 
 

AN ASSESSMENT ON THE MONETARY BUSINESS CYCLE THEORY

In recent years, considerable attention has given to analyzing the business cycle in terms of money. Many researchers have developed dynamic stochastic general equilibrium models that generate business cycle facts and guide for making monetary policy decisions. The aim of this study is to investigate how the persistence of total factor productivity (TFP) and money growth shocks drive the business cycles within an economy. To achieve this aim, we employ a monetary business cycle model with a cash-in-advance constraint, as in Cooley and Hansen (1995). Our results indicate that the volatility of macroeconomic variables is higher when the persistence of TFP shocks is greater compared to that of money growth shocks. Furthermore, TFP shocks seem to have a more significant role in driving variability within the models compared to money growth shocks. This is demonstrated by the higher percentage of variance decomposition attributed to TFP shocks, except in the case of consumption variability.

The Role of Money in Turkish Economy

A well functioning monetary policy requires the knowledge of the effects of monetary aggregates on output and inflation. In this study, we try to analyze the role of money in a monetary business cycle model in the case of Turkey during the 2006-2017 period. Estimation results of the structural model are also compared with single equations’ estimation results and it is found out that the results of the structural model and single equations are quietly different. The differences show that the results of single equation estimations should cautiously be interpreted. In the model, it is found out that real balances have effects on IS and Philips curves.

A MONETARY BUSINESS CYCLE MODEL FOR INDIA

A New Keynesian monetary business cycle model is constructed to study why monetary transmission in India is weak. Our models feature banking and financial sector frictions as well as an informal sector. The predominant channel of monetary transmission is a credit channel. Our main finding is that base money shocks have a larger and more persistent effect on output than an interest rate shock, as in the data. The presence of an informal sector hinders monetary transmission. Contrary to the consensus view, financial repression in the form of a statutory liquidity ratio and administered interest rates, does not weaken monetary transmission. (JEL E31, E32, E44, E52, E63)

The Risk-Adjusted Monetary Policy Rule

Macroeconomists are increasingly using nonlinear models to account for the effects of risk in the analysis of business cycles. In the monetary business cycle models widely used at central banks, an explicit recognition of risk generates a wedge between the inflation-target parameter in the monetary policy rule and the risky steady state (RSS) of inflation---the rate to which inflation will eventually converge---which can be undesirable in some practical applications. We propose a simple modification to the standard monetary policy rule to eliminate the wedge. In the proposed risk-adjusted policy rule, the intercept of the rule is modified so that the RSS of inflation equals the inflation-target parameter in the policy rule.

The Risk-Adjusted Monetary Policy Rule

Macroeconomists are increasingly using nonlinear models to account for the effects of risk in the analysis of business cycles. In the monetary business cycle models widely used at central banks, an explicit recognition of risk generates a wedge between the inflation-target parameter in the monetary policy rule and the risky steady state (RSS) of inflation - the rate to which inflation will eventually converge - which can be undesirable in some practical applications. We propose a simple modification to the standard monetary policy rule to eliminate the wedge. In the proposed risk-adjusted policy rule, the intercept of the rule is modified so that the RSS of inflation equals the inflation-target parameter in the policy rule. JEL Classification: E32, E52

Structural and Cyclical Forces in the Labor Market During the Great Recession: Cross-Country Evidence

We use an estimated monetary business cycle model with search and matching frictions in the labor market and nominal price and wage rigidities to study four countries (the U.S., the U.K., Sweden, and Germany) during the financial crisis and the Great Recession. We estimate the model over the period prior to the financial crisis and use the model to interpret movements in GDP, unemployment, vacancies, and wages in the period from 2007 until 2011. We show that contractionary financial factors and reduced efficiency in labor market matching were largely responsible for the experience in the U.S. Financial factors were also important in the U.K., but less so in Sweden and Germany. Reduced matching efficiency was considerably less important in the U.K. and Sweden than in the U.S., but matching efficiency improved in Germany, helping to keep unemployment low. A counterfactual experiment suggests that unemployment in Germany would have been substantially higher if the German labor market had been more similar to that in the U.S.

Business cycle theories and their relevance to the current global crisis

Ever since the onset of the recent crisis, monetary business cycle theories have started to regain their relevance and timeliness in explaining business fluctuations. According to these theories, it is monetary mismanagement that lies at the bottom of macroeconomic dysfunctions in the intertemporal allocation of resources. This paper presents the main theoretical implications of monetary business cycle models, regarding the causes of the cycle and the appropriate policies required to overcome recessions. In addition, we investigate whether, at the policy level, macroeconomists are indeed addressing the causes of the business cycle, in order to provide feasible solutions to end recessions.

Structural and Cyclical Forces in the Labor Market during the Great Recession: Cross-Country Evidence

We use an estimated monetary business cycle model with search and matching frictions in the labor market and nominal price and wage rigidities to study four countries (the U.S., the U.K., Sweden, and Germany) during the financial crisis and the Great Recession. We estimate the model over the period prior to the financial crisis and use the model to interpret movements in GDP, unemployment, vacancies, and wages in the period from 2007 until 2011. We show that contractionary financial factors and reduced efficiency in labor market matching were largely responsible for the experience in the U.S. Financial factors were also important in the U.K., but less so in Sweden and Germany. Reduced matching efficiency was considerably less important in the U.K. and Sweden than in the U.S., but matching efficiency improved in Germany, helping to keep unemployment low. A counterfactual experiment suggests that unemployment in Germany would have been substantially higher if the German labor market had been more similar to that in the U.S.

Determinacy, indeterminacy and dynamic misspecification in linear rational expectations models

This paper proposes a testing strategy for the null hypothesis that a multivariate linear rational expectations (LRE) model may have a unique stable solution (determinacy) against the alternative of multiple stable solutions (indeterminacy). The testing problem is addressed by a misspecification-type approach in which the overidentifying restrictions test obtained from the estimation of the system of Euler equations of the LRE model through the generalized method of moments is combined with a likelihood-based test for the cross-equation restrictions that the model places on its reduced form solution under determinacy. The resulting test has no power against a particular class of indeterminate equilibria, hence the non rejection of the null hypothesis can not be interpreted conclusively as evidence of determinacy. On the other hand, this test (i) circumvents the nonstandard inferential problem generated by the presence of the auxiliary parameters that appear under indeterminacy and that are not identifiable under determinacy, (ii) does not involve inequality parametric restrictions and hence the use of nonstandard inference, (iii) is consistent against the dynamic misspecification of the LRE model, and (iv) is computationally simple. Monte Carlo simulations show that the suggested testing strategy delivers reasonable size coverage and power against dynamic misspecification in finite samples. An empirical illustration focuses on the determinacy/indeterminacy of a New Keynesian monetary business cycle model of the US economy.

Transmission mechanisms of real stochastic shocks in a small open economy

We offer a qualitative evaluation of the transmission mechanisms of two real shocks, a productivity shock and a government expenditure shock in Walrasian business cycle models. The analysis is developed in a monetary small open economy business cycle model, a set-up general enough to study the effects of the two shocks on both real and nominal variables. Qualitative and graphical displays indicate properties of Real Business Cycles that are able to reproduce observed cyclical patterns, independently of the calibration used for different economies. These qualitative findings match the quantitative results found in the literature, and rationalize some disparity findings (such as the cyclicity pattern of prices) and failures (such as the Dunlop–Tarshis observation). We suggest that understanding the underlying qualitative intuitions of these models may be of great help in tackling new puzzles in this area.

Does Money Matter in Shaping Domestic Business Cycles? An International Investigation

We study the contribution of money to business cycle ‡uctuations in the US, the UK, Japan, and the Euro area using a small scale structural monetary business cycle model. Constrained likelihood-based estimates of the parameters are provided and time instabilities analyzed. Real balances are statistically important for output and in‡ation ‡uctuations. Their contribution changes over time. Models giving money no role provide a distorted representation of the sources of cyclical ‡uctuations, of the transmission of shocks and of the events of the last 40 years.

News versus Sunspot Shocks in a New Keynesian Model

Abstract Separately, news and sunspot shocks have been shown empirically to be determinants of changes in expectations. This paper considers both of them together in a simple New Keynesian monetary business cycle model. A full set of rational expectations solutions is derived analytically. The analytical characterization allows an explicit comparison of news about future monetary policy and sunspots. The key distinction between the shocks lies in their relation to the realized policy shock. If monetary policy is “passive”, both types of shocks affect model dynamics through forecast errors. The effect of the news on forecast errors is not unique, and the dynamics induced by news and sunspot shocks can be observationally equivalent. If monetary policy is “active”, the sunspots are irrelevant, and the model responses to the news shocks are unique. In both cases, news shocks strengthen the endogenous propagation of the model, since anticipation of future changes prolongs agents’ reaction. Keywords: news shocks, sunspots, expectations, monetary policy, indeterminacy.

Evaluating a Monetary Business Cycle Model with Unemployment for the Euro Area

This paper estimates a medium-scale DSGE model with search unemployment by matching model and data spectra. Price mark-up shocks emerge as the main source of business-cycle fluctuations in the euro area. Key factors in the propagation of these disturbances are a high degree of inflation indexation and a persistent response of monetary policy to deviations from the inflation target.

Money Velocity in an Endogenous Growth Business Cycle with Credit Shocks

The paper sets the neoclassical monetary business cycle model within endogenous growth, adds exchange credit shocks, and finds that money and credit shocks explain much of the velocity variations. The role of the shocks varies across subperiods in an intuitive fashion. Endogenous growth is key to the construction of the money and credit shocks because these have similar effects on velocity, but opposite effects upon growth. The model matches the data's average velocity and simulates well velocity volatility. Its Cagan‐like money demand means that money and credit shocks cause greater velocity variation, the higher is the nominal interest rate.

A dynamic new Keynesian life-cycle model: Societal aging, demographics, and monetary policy

In this paper, we first construct a dynamic new Keynesian model that incorporates life-cycle behavior a la Gertler [1999. Government debt and social security in a life-cycle economy. Carnegie–Rochester Conference Series on Public Policy 50, 61–110], in order to study whether structural shocks to the economy have asymmetric effects on heterogeneous agents, namely workers and retirees. We also examine whether considerations of life-cycle and demographic structure alter the dynamic properties of the monetary business cycle model, specifically the degree of amplification in impulse responses. According to our simulation results, shocks indeed have asymmetric impacts on different households and the demographic structure does alter the size of responses against shocks by changing the trade-off between substitution and income effects.

Taxation and the Taylor principle

A nominal tax system is added to a sticky-price monetary business cycle model. When nominal interest income is taxed, the coefficient on inflation in a Taylor-type monetary policy rule must be significantly larger than one in order for the model economy to have a determinate rational-expectations equilibrium. When effective tax rates are raised by inflation, the stability of the economy's equilibrium can be adversely affected. Finally, when depreciation is treated as a charge against taxable income, an even larger weight on inflation is required in the Taylor rule in order to obtain a determinate and stable equilibrium.

Taxation and the Taylor Principle

We add a nominal tax system to a sticky-price monetary business cycle model. When nominal interest income is taxed, the coefficient on inflation in a Taylor-type monetary policy rule must be significantly larger than one in order for the model economy to have a determinate rational expectations equilibrium. When depreciation is treated as a charge against taxable income, an even larger weight on inflation is required in the Taylor rule in order to obtain a determinate and stable equilibrium. These results have obvious implications for assessing the historical conduct of monetary policy.

A monetary business cycle model with unemployment

To reproduce key features of the post-war U.S. data, most monetary business cycle models must assume there are high price markups and that agents have high labour supply elasticities despite the existence of contradictory microeconomic evidence. This paper eliminates the need for these assumptions by introducing imperfectly observed effort into a limited participation model. The estimated model is better able to capture the sluggish price response to a monetary policy shock than the standard model, and is consistent with evidence regarding the qualitative responses of the U.S. economy to technology shocks, fiscal policy shocks and monetary policy shocks.

Time-to-Build, Time-to-Plan, Habit-Persistence, and the Liquidity Effect

The general inability of sticky-price monetary business cycle models to generate liquidity effects has been noted in the recent literature by authors such as Christiano (1991), Christiano and Eichenbaum (1992a, 1995), King and Watson (1996), and Bernanke and Mihov (1998b). This paper develops a sticky-price monetary business cycle model that is capable of generating an empirically plausible liquidity effect. Time-to-build and time-to-plan in investment together with habit-persistence in consumption are the features of the model that allow it to produce this result.