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Money, Prices, Interest Rates and the Business Cycle

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  • King, Robert G
  • Watson, Mark W

Abstract

The mechanisms governing the relationship of money, prices and interest rates to the business cycle are the most studied and most disputed topics in macroeconomics. In this paper, we first document key empirical aspects of this relationship. We then ask how well three benchmark rational expectations macroeconomic models--real business cycle model, a sticky price model and a liquidity effect model--account for these central facts. While the models have diverse successes and failures, none can account for the fact that real and nominal interest rates are 'inverted leading indicators' of real economic activity. That is, none of the models captures the post-war U.S. business cycle fact that a high real or nominal interest rate in the current quarter predicts a low level of real economic activity two to four quarters in the future. Copyright 1996 by MIT Press.

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Bibliographic Info

Article provided by MIT Press in its journal Review of Economics & Statistics.

Volume (Year): 78 (1996)
Issue (Month): 1 (February)
Pages: 35-53

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Handle: RePEc:tpr:restat:v:78:y:1996:i:1:p:35-53

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  1. Gray, Jo Anna, 1978. "On Indexation and Contract Length," Journal of Political Economy, University of Chicago Press, vol. 86(1), pages 1-18, February.
  2. King, Robert G. & Plosser, Charles I. & Stock, James H. & Watson, Mark W., 1991. "Stochastic Trends and Economic Fluctuations," American Economic Review, American Economic Association, vol. 81(4), pages 819-40, September.
  3. Robert S. Chirinko, 1993. "Business fixed investment spending: a critical survey of modeling strategies, empirical results, and policy implications," Research Working Paper 93-01, Federal Reserve Bank of Kansas City.
  4. Fuerst, Timothy S., 1992. "Liquidity, loanable funds, and real activity," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 3-24, February.
  5. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  6. Soderlind, Paul, 1994. "Cyclical Properties of a Real Business Cycle Model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 9(S), pages S113-22, Suppl. De.
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  1. Michael Woodford: Revolución y Evolución en la Macroeconomía del siglo XX
    by Enrique Bour in Foco Económico on 2011-03-16 12:00:00
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