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The role of money in a business cycle model

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  • Finn E. Kydland

Abstract

Two mechanisms are considered through which money can play a role in a real business cycle model. One is in the form of aggregate price surprises when there is heterogeneity across individuals or groups of individuals (islands). These shocks affect the accuracy of information about real compensation that can be extracted from observed wage rates. Another, perhaps complementary, mechanism is that the amount of desired liquidity services varies over the cycle due to a trade-off between real money and leisure. This mechanism leads to price fluctuations even when the nominal money stock does not fluctuate. As is the case for the U.S. economy over the postwar period, the price level is then countercyclical. A key finding is that with neither mechanism do nominal shocks account for more than a small amount of variability in real output and in hours worked. Indeed, output variability may very well be lower the larger the variance of price surprises is.

Suggested Citation

  • 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.
    • Handle: RePEc:fip:fedmem:23
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    Citations

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    Cited by:

    1. Altig, David & Carlstrom, Charles T, 1991. "Inflation, Personal Taxes, and Real Output: A Dynamic Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 547-571, August.
    2. Louis Phaneuf & Jang-Ok Cho, 1992. "A Business Cycle Model with Nominal Wage Contracts and Government," Cahiers de recherche CREFE / CREFE Working Papers 6, CREFE, Université du Québec à Montréal, revised Jan 1993.
    3. Finn E. Kydland & Edward C. Prescott, 1996. "The Computational Experiment: An Econometric Tool," Journal of Economic Perspectives, American Economic Association, vol. 10(1), pages 69-85, Winter.
    4. Giovannini, Alberto & Labadie, Pamela, 1991. "Asset Prices and Interest Rates in Cash-in-Advance Models," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1215-1251, December.
    5. Schlagenhauf, Don E. & Wrase, Jeffrey M., 1995. "Liquidity and real activity in a simple open economy model," Journal of Monetary Economics, Elsevier, vol. 35(3), pages 431-461, June.
    6. Thomas F. Cooley & Gary D. Hansen, 1997. "Unanticipated money growth and the business cycle reconsidered," Proceedings, Federal Reserve Bank of Cleveland, issue Nov, pages 624-652.
    7. Christiano, Lawrence J & Eichenbaum, Martin, 1995. "Liquidity Effects, Monetary Policy, and the Business Cycle," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 1113-1136, November.
    8. Stuart J. Fowler, 2005. "Income Inequality, Monetary Policy, and the Business Cycle," Working Papers 200507, Middle Tennessee State University, Department of Economics and Finance.
    9. Lawrence J. Christiano & Martin S. Eichenbaum, 1992. "Liquidity effects, the monetary transmission mechanism, and monetary policy," Economic Perspectives, Federal Reserve Bank of Chicago, vol. 16(Nov), pages 2-14.
    10. Cooley, Thomas F. & Hansen, Gary D., 1998. "The role of monetary shocks in equilibrium business cycle theory: Three examples," European Economic Review, Elsevier, vol. 42(3-5), pages 605-617, May.
    11. Jeanne, Olivier, 1998. "Generating real persistent effects of monetary shocks: How much nominal rigidity do we really need?," European Economic Review, Elsevier, vol. 42(6), pages 1009-1032, June.
    12. Mark A. Wynne, 1995. "Sticky prices: what is the evidence?," Economic and Financial Policy Review, Federal Reserve Bank of Dallas, issue Q I, pages 1-12.
    13. 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.
    14. William T. Gavin & Finn E. Kydland, 1999. "Endogenous Money Supply and the Business Cycle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(2), pages 347-369, April.
    15. Salyer, Kevin D., 1996. "Interpreting a stochastic monetary growth model as a modified social planner's problem," Journal of Economic Dynamics and Control, Elsevier, vol. 20(4), pages 681-689, April.
    16. Chang, Ly-June, 1995. "Business cycles with distorting taxes and disaggregated capital markets," Journal of Economic Dynamics and Control, Elsevier, vol. 19(5-7), pages 985-1009.
    17. Don E. Schlagenhauf & Jeffrey M. Wrase, 1992. "Liquidity and real activity in three monetary models," Discussion Paper / Institute for Empirical Macroeconomics 68, Federal Reserve Bank of Minneapolis.
    18. Lee, Kiseok & Ratti, Ronald A., 1996. "On asymmetric costs of disequilibrium and forecasting money demand," Journal of Macroeconomics, Elsevier, vol. 18(2), pages 271-288.
    19. Ingram, B., 1990. "Post Econometric Policy Evaluation : A Critique," Working Papers 90-30, University of Iowa, Department of Economics.

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    Keywords

    Business cycles; Money;

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