IDEAS home Printed from https://ideas.repec.org/p/fip/fednrp/9528.html
   My bibliography  Save this paper

Regime-switching monetary policy and real business cycle fluctuations

Author

Listed:
  • Fangxiong Gong

Abstract

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."

Suggested Citation

  • Fangxiong Gong, 1995. "Regime-switching monetary policy and real business cycle fluctuations," Research Paper 9528, Federal Reserve Bank of New York.
  • Handle: RePEc:fip:fednrp:9528
    as

    Download full text from publisher

    File URL: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/research_papers/9528.html
    Download Restriction: no

    File URL: https://www.newyorkfed.org/medialibrary/media/research/staff_reports/research_papers/9528.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, vol. 69(2), pages 108-113, May.
    2. 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.
    3. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
    4. Cooley, Thomas F & Hansen, Gary D, 1989. "The Inflation Tax in a Real Business Cycle Model," American Economic Review, American Economic Association, vol. 79(4), pages 733-748, September.
    5. 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.
    6. 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.
    7. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Liquidity Effects and the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 82(2), pages 346-353, May.
    8. Cooley, Thomas F. & Ohanian, Lee E., 1991. "The cyclical behavior of prices," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 25-60, August.
    9. 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.
    10. 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 357-384, March.
    11. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, pages 245-274.
    12. 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.
    13. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    14. Lucas, Robert E, Jr, 1975. "An Equilibrium Model of the Business Cycle," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1113-1144, December.
    15. 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.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Dueker Michael & Fischer Andreas & Dittmar Robert, 2007. "Stochastic Capital Depreciation and the Co-movement of Hours and Productivity," The B.E. Journal of Macroeconomics, De Gruyter, pages 1-24.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. 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). General contact details of provider: http://edirc.repec.org/data/frbnyus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.