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Interest Rate Policy and the Price Puzzle in a Quantitative Business Cycle Model

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  • Schabert, Andreas

    (Department of Economics, University of Cologne)

Abstract

In the empirical literature, monetary policy shocks are commonly measured as an innovation to a short-term nominal interest rate. In contrast, the majority of monetary business cycle models treats a broad monetary aggregate as the central bank's policy measure. We try overcome this disparity and present a business cycle model which allows to examine the effects of innovations to a non-contingent nominal interest rate rule. To obtain unique rational expectations equilibria we assume that changes in money supply are brought about open market operations. In addition to working capital, we consider staggered prices which enables real marginal costs to vary. Consistent with the empirical findings of Barth and Ramey (2000), the model predicts that real marginal cost and inflation rise in response to positive interest rate innovations. The mechanism corresponds to their 'Cost Channel of Monetary Transmission' and replicates typical monetary VAR results, including the puzzling behavior of prices.

Suggested Citation

  • Schabert, Andreas, 2001. "Interest Rate Policy and the Price Puzzle in a Quantitative Business Cycle Model," Economics Series 95, Institute for Advanced Studies.
    • Handle: RePEc:ihs:ihsesp:95
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    File URL: https://irihs.ihs.ac.at/id/eprint/1323
    File Function: First version, 2001
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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