Regime-switching monetary policy and real business cycle fluctuations
This paper investigates the implications of a regime switching monetary policy on real business cycle fluctuations. In a Cash-in-Advance model, a regime switching monetary policy with the typical observed business cycle durations could cause sizable fluctuations in real variables such as consumption, and to a lesser extent, investment. The correlations of these real variables with output matched those in the data very well. It is also found that the expected durations of the monetary policy in each regime have a significant effect on the fluctuation of real variables such as consumption and investment. In the longer duration case, the agents would supply more hours and invest less (thus consume more) in the low inflation regime than in the high inflation regime. However, if the monetary policy has a very short expected duration in each regime and switches a lot between the states, the agents' decision rules in different regimes will be close, and contrary to the long duration case, hours are a little lower and investment a little higher in the lower money growth regime than in the higher growth regime. The findings are consistent with the agents' behavior with rational expectations. Adding monetary shock in real business cycle models helps to explain the fluctuations not only in monetary and price variables, but also in real variables. Compared to a non-monetary model, the variations in the model economy are closer to what we see in the data. The implication is that, if there are different policy regimes and people are uncertain about the timing of policy changes, then the expected duration of monetary policy could affect the size of business cycle fluctuations even in a world where agents are assumed to behave rationally and there are no "confusions" or "rigidities."
|Date of creation:||1995|
|Date of revision:|
|Contact details of provider:|| Postal: 33 Liberty Street, New York, NY 10045-0001|
Web page: http://www.newyorkfed.org/
More information through EDIRC
|Order Information:|| Email: |
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, vol. 69(2), pages 108-13, May.
- Cooley, T.F. & Hansen, G.D., 1988.
"The Inflation Tax In A Real Business Cycle Model,"
RCER Working Papers
155, University of Rochester - Center for Economic Research (RCER).
- Cooley, Thomas F. & Ohanian, Lee E., 1991.
"The cyclical behavior of prices,"
Journal of Monetary Economics,
Elsevier, vol. 28(1), pages 25-60, August.
- Eli M. Remolona & Joseph Dziwura & Irene Pedraza, 1995. "The short end of the forward convergence curve and asymmetric cat's tail convergence," Research Paper 9523, Federal Reserve Bank of New York.
- Rudebusch, Glenn D., 1995.
"Federal Reserve interest rate targeting, rational expectations, and the term structure,"
Journal of Monetary Economics,
Elsevier, vol. 35(2), pages 245-274, April.
- Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
- Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
- 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.
- Gary D. Hansen, . "GAUSS code for the Imrohoroglu (1989) model without aggregate uncertainty," QM&RBC Codes 10, Quantitative Macroeconomics & Real Business Cycles.
- Gary D. Hansen, . "GAUSS code useful for many RBC models," QM&RBC Codes 6, Quantitative Macroeconomics & Real Business Cycles.
- Gary D. Hansen, . "GAUSS code for the basic Hansen (1985) model," QM&RBC Codes 7, Quantitative Macroeconomics & Real Business Cycles.
- Gary D. Hansen, . "GAUSS code for a basic model with money, cash-in-advance constraint," QM&RBC Codes 8, Quantitative Macroeconomics & Real Business Cycles.
- Gary D. Hansen, . "GAUSS code for an overlapping generations model with inelastic labor supply," QM&RBC Codes 9, Quantitative Macroeconomics & Real Business Cycles.
- Christiano, Lawrence J & Eichenbaum, Martin, 1992.
"Liquidity Effects and the Monetary Transmission Mechanism,"
American Economic Review,
American Economic Association, vol. 82(2), pages 346-53, May.
- Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects and the monetary transmission mechanism," Staff Report 150, Federal Reserve Bank of Minneapolis.
- Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity Effects and the Monetary Transmission Mechanism," NBER Working Papers 3974, National Bureau of Economic Research, Inc.
- Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
- N. Gregory Mankiw, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model of Monopoly," The Quarterly Journal of Economics, Oxford University Press, vol. 100(2), pages 529-538.
- Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
- Parkin, Michael, 1986. "The Output-Inflation Trade-off When Prices Are Costly to Change," Journal of Political Economy, University of Chicago Press, vol. 94(1), pages 200-224, February.
- Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
- Edward C. Prescott, 1993. "Effects of alternative monetary stabilization policies: an unexpected finding," Working Papers in Applied Economic Theory 93-06, Federal Reserve Bank of San Francisco.
- Lucas, Robert E, Jr, 1975. "An Equilibrium Model of the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1113-44, December.
When requesting a correction, please mention this item's handle: RePEc:fip:fednrp:9528. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Amy Farber)
If references are entirely missing, you can add them using this form.