Working Paper: CEPR ID: DP1630
Authors: Roger E. A. Farmer
Abstract: This paper constructs a real business cycle model in which real money balances yield utility. We calibrate the model to fit the first moments of US data and simulate a set of impulse response functions that are generated by the model for GDP, the rate of interest, money growth and real balances. These theoretical impulse responses are compared with actual impulse responses from US data. The model does a reasonably good job of capturing the dynamic interactions of money and real variables in US data. It differs from most existing approaches by choosing a parameterization of utility for which the model admits the existence of indeterminate equilibria. It is argued that this fact is critical in explaining the monetary propagation mechanism.
Keywords: sunspots; indeterminacy; business fluctuations; real business cycle
JEL Codes: E00; E4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Money supply shocks (E51) | Employment (J68) |
| Money supply shocks (E51) | Output (Y10) |
| Real money balances in utility function (E41) | Indeterminate equilibria (D59) |
| Model structure (C52) | Multiple equilibria (D59) |
| Model better explains persistence of monetary shocks (E19) | Money dynamics and real economic variables (E49) |