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Endogenous money supply and the business cycle

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  • William T. Gavin
  • Finn E. Kydland

Abstract

This paper documents changes in the cyclical behavior of nominal data series that appear after 1979:Q3 when the Federal Reserve implemented a policy to lower the inflation rate. Such changes were not apparent in real variables. A business cycle model with impulses to technology and a role for money is used to show how alternative money supply rules are expected to affect observed business cycle facts. In this model, changes in the money supply rules have almost no effect on the cyclical behavior of real variables, yet have a significant impact on the cyclical nature of nominal variables. Computational experiments with alternative policy rules suggest that the change in monetary policy in 1979 may account for the sort of instability observed in the U.S. data.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1995-010.

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Date of creation: 1997
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Publication status: Published in Review of Economic Dynamics, April 1999, 2(2), pp. 347-369
Handle: RePEc:fip:fedlwp:1995-010

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Keywords: Business cycles ; Money supply;

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  1. Pakko, Michael R, 2000. "The Cyclical Relationship between Output and Prices: An Analysis in the Frequency Domain," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 382-99, August.
  2. David K. Backus & Patrick J. Kehoe, 1991. "International evidence on the historical properties of business cycles," Staff Report 145, Federal Reserve Bank of Minneapolis.
  3. Mulligan, Casey B & Sala-I-Martin, Xavier X, 1997. "The Optimum Quantity of Money: Theory and Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 687-715, November.
  4. Finn E. Kydland & Edward C. Prescott, 1990. "Business cycles: real facts and a monetary myth," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr, pages 3-18.
  5. Gilbert Ghez & Gary S. Becker, 1975. "The Allocation of Time and Goods over the Life Cycle," NBER Books, National Bureau of Economic Research, Inc, number ghez75-1, octubre-d.
  6. Christopher A. Sims, 1989. "Models and their uses," Discussion Paper / Institute for Empirical Macroeconomics 11, Federal Reserve Bank of Minneapolis.
  7. Robert E. Lucas, Jr., 1994. "On the welfare cost of inflation," Working Papers in Applied Economic Theory 94-07, Federal Reserve Bank of San Francisco.
  8. Gary D. Hansen & Edward C. Prescott, 1992. "Recursive methods for computing equilibria of business cycle models," Discussion Paper / Institute for Empirical Macroeconomics 36, Federal Reserve Bank of Minneapolis.
  9. Prescott, Edward C., 1986. "Theory ahead of business-cycle measurement," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 11-44, January.
  10. Friedman, Benjamin M & Kuttner, Kenneth N, 1992. "Money, Income, Prices, and Interest Rates," American Economic Review, American Economic Association, vol. 82(3), pages 472-92, June.
  11. Arthur J. Rolnick & Warren E. Weber, 1994. "Inflation, money, and output under alternative monetary standards," Staff Report 175, Federal Reserve Bank of Minneapolis.
  12. Bryan, Michael F. & Gavin, William T., 1994. "A different kind of money illusion: The case of long and variable lags," Journal of Policy Modeling, Elsevier, vol. 16(5), pages 529-540, October.
  13. Smith, R Todd, 1992. "The Cyclical Behavior of Prices," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(4), pages 413-30, November.
  14. Salemi, Michael K, 1995. "Revealed Preference of the Federal Reserve: Using Inverse-Control Theory to Interpret the Policy Equation of a Vector Autoregression," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(4), pages 419-33, October.
  15. Cooley, Thomas F. & Ohanian, Lee E., 1991. "The cyclical behavior of prices," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 25-60, August.
  16. Finn E. Kydland, 1989. "The role of money in a business cycle model," Discussion Paper / Institute for Empirical Macroeconomics 23, Federal Reserve Bank of Minneapolis.
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