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The theoretical framework of monetary policy revisited

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  • Hiona Balfoussia

    ()
    (Bank of Greece)

  • Sophocles N. Brissimis

    ()
    (Bank of Greece)

  • Manthos D. Delis

    (City University)

Abstract

The three-equation New-Keynesian model advocated by Woodford (2003) as a self-contained system on which to base monetary policy analysis is shown to be inconsistent in the sense that its long-run static equilibrium solution implies that the interest rate is determined from two of the system’s equations, while the price level is left undetermined. The inconsistency is remedied by replacing the Taylor rule with a standard money demand equation. The modified system is seen to possess the key properties of monetarist theory for the long run, i.e. monetary neutrality with respect to real output and the real interest rate and proportionality between money and prices. Both the modified and the original New-Keynesian models are estimated on US data and their dynamic properties are examined by impulse response analysis. Our research suggests that the economic and monetary analysis of the European Central Bank could be unified into a single framework.

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Bibliographic Info

Paper provided by Bank of Greece in its series Working Papers with number 138.

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Length: 40
Date of creation: Sep 2011
Date of revision:
Handle: RePEc:bog:wpaper:138

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Keywords: Monetary theory; Central banking; New-Keynesian model; Impulse response analysis;

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Cited by:
  1. Seitz, Franz & Schmidt, Markus A., 2014. "Money in modern macro models: A review of the arguments," OTH im Dialog: Weidener Diskussionspapiere 37, University of Applied Sciences Amberg-Weiden (OTH).
  2. Ronny Mazzocchi, 2013. "Investment-Saving Imbalances with Endogenous Capital Stock," DEM Discussion Papers 2013/14, Department of Economics and Management.

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