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A Classical View of the Business Cycle

Author

Listed:
  • Michael T. Belongia

    (University of Mississippi)

  • Peter N. Ireland

    () (Boston College)

Abstract

In the 1920s, Irving Fisher extended his previous work on the Quantity Theory to describe how, through an early version of the Phillips Curve, changes in the price level could affect both output and unemployment. At the same time, Holbrook Working designed a quantitative rule for achieving price stability through control of the money supply. This paper develops a structural vector autoregressive time series model that allows these "classical" channels of monetary transmission to operate alongside, or perhaps even instead of, the now-more-familiar interest rate channels of the canonical New Keynesian model. Even with Bayesian priors that intentionally favor the New Keynesian view, the United States data produce posterior distributions for the model's key parameters that are more consistent with the ideas of Fisher and Working. Changes in real money balances enter importantly into the model's aggregate demand relationship, while growth in Divisia M2 appears in the estimated monetary policy rule. Contractionary monetary policy shocks reveal themselves through persistent declines in nominal money growth instead of rising nominal interest rates. These results point to the need for new theoretical models that capture a wider range of channels through which monetary policy affects the economy and suggest that, even today, the monetary aggregates could play a useful role in the Federal Reserve's policymaking strategy.

Suggested Citation

  • Michael T. Belongia & Peter N. Ireland, 2016. "A Classical View of the Business Cycle," Boston College Working Papers in Economics 921, Boston College Department of Economics.
  • Handle: RePEc:boc:bocoec:921
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    References listed on IDEAS

    as
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. More on the History of Distributed Lag Models
      by Dave Giles in Econometrics Beat: Dave Giles' Blog on 2016-12-28 19:41:00

    More about this item

    Keywords

    Bayesian vector autoregression; Divisia monetary aggregate; Monetary transmission mechanism; New Keynesian model; Quantity Theory of money;

    JEL classification:

    • B12 - Schools of Economic Thought and Methodology - - History of Economic Thought through 1925 - - - Classical (includes Adam Smith)
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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