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How Well Does a Monetary Dynamic Equilibrium Model Account for Chilean Data?

  • Roberto Duncan

The purpose of this paper is to figure out how well a money-in-the-utility-function model with a Taylor rule can match Chilean data, specially some monetary stylized facts. A dynamic stochastic general equilibrium model is formulated, solved and calibrated to evaluate its ability to replicate the main features of the Chilean economy in the 1986-2000 period. In particular, it focuses on a possible explanation to what the empirical literature calls the "price puzzle", the co-movement between interest rate and inflation. The solution of the model is adequately achieved through a perturbation method (second-order approximation). A positive transitory policy interest rate shock causes: (1) a temporary (non-significant) decline in output, (2) a decrease in real money balances, and (3) a temporary increase in the inflation rate. These findings are relatively consistent with those obtained from impulse-response functions estimated for Chile. Therefore, the theoretical model proposed is able to explain and reproduce the co-movement between interest rate and inflation. This relationship is caused by a Fisher effect and strengthened by the presence of a Taylor rule that depends positively on inflation deviation from its steady state equilibrium.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 190.

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Date of creation: Nov 2002
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Handle: RePEc:chb:bcchwp:190
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  1. Raphael Bergoeing & Patrick J. Kehoe & Timothy J. Kehoe & Raimundo Soto, 2002. "A Decade Lost and Found: Mexico and Chile in the 1980s," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 5(1), pages 166-205, January.
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  7. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1997. "Sticky price and limited participation models of money: A comparison," European Economic Review, Elsevier, vol. 41(6), pages 1201-1249, June.
  8. Fernando Alvarez & Robert E. Lucas, Jr. & Warren E. Weber, 2001. "Interest rates and inflation," Working Papers 609, Federal Reserve Bank of Minneapolis.
  9. Lawrence J. Christiano & Christopher J. Gust, 1999. "Taylor rules in a limited participation model," Working Paper 9902, Federal Reserve Bank of Cleveland.
  10. Robert J. Hodrick & Edward Prescott, 1981. "Post-War U.S. Business Cycles: An Empirical Investigation," Discussion Papers 451, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Greenwood, Jeremy & Hercowitz, Zvi & Krusell, Per, 2000. "The role of investment-specific technological change in the business cycle," European Economic Review, Elsevier, vol. 44(1), pages 91-115, January.
  12. Eric Parrado, 2001. "Effects of Foreign and Domestic Monetary Policy in a Small Open Economy: the Case of Chile," Working Papers Central Bank of Chile 108, Central Bank of Chile.
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  14. C.K. Folkertsma, 1998. "Nominal wage contracts, adjustment costs and real persistence of monetary shocks," WO Research Memoranda (discontinued) 566, Netherlands Central Bank, Research Department.
  15. Corbo, Vittorio, 1985. "International Prices, Wages and Inflation in an Open Economy: A Chilean Model," The Review of Economics and Statistics, MIT Press, vol. 67(4), pages 564-73, November.
  16. Shamik Dhar & Stephen P Millard, 2000. "A limited participation model of the monetary transmission mechanism in the United Kingdom," Bank of England working papers 117, Bank of England.
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