The purpose of this study is to illustrate how the basic Real Business Cycle (RBC) model can be modified to incorporate money in an attempt to construct monetary business cycle models of the U.S. economy. This is done for one case where money enters the model as direct lump-sum transfers to households and for the other case where money injections enter the economy through the financial system. Interestingly, the two channels generate very different responses to a money growth shock. In the first case, a positive money growth shock increases nominal interest rates and depresses economic activity, which is called the anticipated inflation effect. However, the popular consensus among economists is that nominal interest rates fall after a positive monetary shock. This motivates the construction of our second model where it is conjectured that the banking sector plays an important role in the monetary transmission mechanism and money is injected into the model through financial intermediaries. It is observed in this model that a positive monetary shock reduces interest rates and stimulates economic activity, which is called the liquidity effect. Furthermore, the statistics generated by the models show that monetary shocks have no effect on real variables when money enters as direct lump-sum transfers to households. On the contrary, such shocks have significant real impact when money enters through the financial system. Taken together, this implies that how money enters into the model significantly matters for the impact of monetary shocks and such shocks entering through financial intermediaries may be important in determining the cyclical fluctuations of the U.S. economy.
Table of Contents
1 Introduction
2 Literature review
3 Data
4 Stylized Facts of U.S. Business Cycles
4.1 The Hodrick-Prescott Filter
4.2 Features of U.S. business cycles
5 Baseline Cash-in-Advance Model
5.1 The Structure
5.2 The Full Model
5.3 The Stationary State
5.4 Calibration
5.5 Impulse Responses for Cash-in-Advance Model
5.5.1 Response to a technology shock
5.5.2 Response to a money growth shock
5.6 Assessing the baseline Cash-in-Advance Model
6 Working Capital Model
6.1 The Structure
6.1.1 Households
6.1.2 Firms
6.1.3 Financial Intermediaries
6.1.4 Monetary Policy
6.2 The Optimization Problem
6.2.1 The Representative Household’s Problem
6.2.2 The Representative Firm’s Problem
6.3 The Competitive Equilibrium
6.4 The Stationary State
6.5 Impulse Responses for Working Capital Model
6.5.1 Response to a technology shock
6.5.2 Response to a money growth shock when η = 0
6.5.3 Response to a money growth shock when η = 1
6.6 Assessing the Working Capital Model when η = 0
6.7 Assessing the Working Capital Model when η = 1
7 Discussion
8 Conclusion
Research Objectives and Key Topics
This study aims to modify the basic Real Business Cycle (RBC) model to investigate the role of monetary shocks in driving cyclical fluctuations within the U.S. economy. By constructing two distinct models—one with direct lump-sum transfers and one with a banking sector—the research evaluates how the mechanism of monetary injection influences real economic variables and nominal aggregates.
- Construction of monetary business cycle models using RBC frameworks.
- Quantitative comparison of money injection channels (direct transfers vs. financial intermediaries).
- Analysis of the anticipated inflation effect versus the liquidity effect.
- Empirical evaluation of business cycle features through impulse response functions and simulation statistics.
Excerpt from the Book
5.5.2 Response to a money growth shock
We can see the response of this economy to a positive 1 per cent money growth shock delineated in Figure 4. The very clear reaction is that of prices which respond very quickly to the one time money growth shock resulting in inflation in this economy. In this model, inflation occurs through lump-sum transfers of money directly to consumers. These transfers reduce the return on money held over from the previous period and reduce incentives to use money. Since it is a money growth shock and not just a money supply shock, a surprise increase in money leads people to expect more such increases in the future and so more inflation, which is captured by the autoregressive process for money growth. This results in borrowers and lenders adding an inflation premium to interest rates and consequently nominal interest rates are pushed up. The rise in interest rate implies that the opportunity cost of holding money is now higher. Thereby, in increasing the expected inflation rate and the nominal interest rate, a positive money growth shock acts as a tax, called inflation tax, on consumption. Basic economic intuition tells us that when the opportunity cost of some activity increases, people do less of that activity. Accordingly, the inflation tax on consumption induces individuals to substitute leisure for consumption. This would then lower the labor supply in the aggregate economy and depress economic activity causing a fall in output as seen in the figure. This phenomenon is known as the anticipated inflation effect of a money growth shock.
Summary of Chapters
1 Introduction: Provides an overview of business cycle research, the transition from real to monetary theories, and the research objectives of this thesis.
2 Literature review: Discusses the evolution of economic thought regarding money neutrality, the anticipated inflation effect, and the development of RBC models.
3 Data: Explains the sources and measurement techniques used to align empirical U.S. quarterly data with the model variables.
4 Stylized Facts of U.S. Business Cycles: Details the use of the Hodrick-Prescott filter and establishes the core empirical characteristics of the U.S. business cycle.
5 Baseline Cash-in-Advance Model: Develops a model where money is injected via direct lump-sum transfers and examines the resulting anticipated inflation effect.
6 Working Capital Model: Introduces financial intermediaries into the framework to analyze how different channels of money injection create the liquidity effect.
7 Discussion: Synthesizes the findings and discusses the implications of different money transmission mechanisms on business cycle fluctuations.
8 Conclusion: Summarizes the study’s contributions and suggests future research directions, such as extending the model to open economies.
Keywords
Business cycle, money growth shock, monetary transmission mechanism, financial intermediaries, anticipated inflation effect, liquidity effect, real business cycle, RBC, nominal interest rate, inflation tax, neoclassical growth model, U.S. economy, Hodrick-Prescott filter, calibration, structural vector autoregression.
Frequently Asked Questions
What is the primary focus of this research?
The work focuses on constructing and testing Real Business Cycle models that incorporate money to explain economic fluctuations in the United States.
What are the central themes of the thesis?
The central themes include the modeling of money demand, the analysis of different monetary injection channels, and the role of financial intermediaries in the transmission of monetary shocks.
What is the main research question or goal?
The primary goal is to determine whether and how monetary forces, specifically money growth shocks, can explain business cycle fluctuations beyond traditional technology shocks.
Which scientific methods are employed?
The study uses neoclassical general equilibrium modeling, numerical simulation, log-linearization of non-linear models, and the Hodrick-Prescott filter for empirical data processing.
What is covered in the main section of the paper?
The main sections analyze a baseline cash-in-advance model and a working capital model, evaluating their performance against historical U.S. data through impulse responses and summary statistics.
How is this work characterized by its keywords?
The work is characterized by its focus on monetary transmission, the liquidity versus anticipated inflation effects, and the use of calibrated neoclassical models.
How does the role of the banking sector change the model outcomes?
In the working capital model, the inclusion of a banking sector allows money injections to lower borrowing costs for firms, generating a liquidity effect that stimulates economic activity, contrary to the baseline model's anticipated inflation effect.
What is the difference between the two cases (η = 0 and η = 1) analyzed in the Working Capital Model?
The cases distinguish between models where current wage income cannot be used for consumption (η = 0) and models where it can (η = 1), affecting the intra-temporal versus inter-temporal trade-offs households face when reacting to shocks.
- Citar trabajo
- Qazi Haque (Autor), 2013, The Role of Monetary Shocks in the U.S. Business Cycle, Múnich, GRIN Verlag, https://www.grin.com/document/293495
