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Money and Monetary Policy in Stochastic General Equilibrium Models

  • Arnab Bhattacharjee
  • Christoph Thoenissen

    ()

We compare two methods of motivating money in New Keynesian DSGE Models: Money-in-the-utility function and cash-in-advance constraint, as well as two ways of modelling monetary policy: interest rate feedback rule and money growth rules. As an aid to model selection, we use a new econometric measure of the distance between model and data variance-covariance matrices. The proposed measure is useful in distinguishing between alternative general equilibrium models. We find that the models closed by an estimated interest rate feedback rule imply counter-cyclical policy and inflation rates, which is at odds with the data. This problem is not a feature of models closed by an estimated money growth rule. Drawing on our econometric analysis, we argue that the cash-in-advance model, closed by a money growth rule, comes closest to the data.

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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200511.

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Date of creation: 15 Oct 2005
Date of revision: 15 Feb 2007
Handle: RePEc:san:cdmawp:0511
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