Stylized fact: high cyclical correlation of monetary aggregates and output
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1 SIMPLE DSGE MODELS OF MONEY PART II SEPTEMBER 27, 2011 Inroducion BUSINESS CYCLE IMPLICATIONS OF MONEY Sylized fac: high cyclical correlaion of moneary aggregaes and oupu Convenional Keynesian view: nominal rigidiies (in price and/or wage level cause moneary shifs o have real effecs Price level Quesion: How far can we go in explaining link beween moneary shifs and real effecs wihou appealing o nominal rigidiies? P 1 Moneary expansion Compleely flexible price level: oupu unaffeced (Parially rigid price level: oupu expands some (Compleely rigid price level: oupu expands a lo D GDP Sepember 27,
2 BUSINESS CYCLE IMPLICATIONS OF MONEY Embed CIA framework in sandard RBC model wih quasi-linear uiliy Can approximae and simulae using usual mehods Cooley and Hansen use LQ (linear-quadraic approximaion a echnique sill in favor in he New Keynesian lieraure bu largely has died ou in oher branches of DSGE macro Consan money growh rae; only z shocks RATIO of SD(hours/SD(produciviy = 2.6 inheried from Hansen-Rogerson quasi-linear preferences. Sepember 27, BUSINESS CYCLE IMPLICATIONS OF MONEY Embed CIA framework in sandard RBC model wih quasi-linear uiliy Can approximae and simulae using usual mehods Cooley and Hansen use LQ (linear-quadraic approximaion a echnique sill in favor in he New Keynesian lieraure bu largely has died ou in oher branches of DSGE macro Consan money growh rae; only z shocks Business cycle dynamics same as Hansen (1985, Table 1! Beer be he case wih he Friedman Rule (almos in place!.but noe hey do no repor dynamics of i Sepember 27, Also do no repor dynamics of π 2
3 BUSINESS CYCLE IMPLICATIONS OF MONEY Exogenous AR(1 governs money growh rae Se parameers (persisence and S.D. of shock o mach firs and second momens of empirical M1 process Low average money growh High average money growh Resul: volailiy of nominal money refleced enirely in nominal prices and consumpion M Makes some sense he binding CIA consrain c = P Dynamics of oher variables virually unaffeced Sepember 27, A PHILLIPS CURVE? Tradeoff beween inflaion and unemploymen he cenerpiece of moneary heory and policy circa 1970 Can CIA model deliver i? Shor-run Phillips Curve: No menion of cyclical correlaion beween π and labor Sepember 27,
4 A PHILLIPS CURVE? Tradeoff beween inflaion and unemploymen he cenerpiece of moneary heory and policy circa 1970 Can CIA model deliver i? Shor-run Phillips Curve: No menion of cyclical correlaion beween π and labor Long-run (i.e., deerminisic seady sae Phillips Curve: negaive relaion beween inflaion and employmen And hus wih oupu, consumpion, invesmen (Seady-sae! inflaion is a ax on consumpion, hence subsiue ino leisure Empirical evidence may suppor upward-sloping long-run (i.e., seady sae, i.e., ime-averaged Phillips Curve Bu is his he same as he operaional Phillips Curve (p. 745? Likely no Sepember 27, WELFARE COSTS OF INFLATION Anoher enduring quesion: Wha are he welfare gains of moving from a high-inflaion o a low-inflaion environmen? Paricular ineres in his quesion in many developing counries and U.S. circa Typical mehod: compue exra percenage of consumpion represenaive agen would require in high-inflaion environmen o be jus as well off (uiliy as in low-inflaion environmen (wihou he consumpion compensaion Sepember 27,
5 WELFARE COSTS OF INFLATION Anoher enduring quesion: Wha are he welfare gains of moving from a high-inflaion o a low-inflaion environmen? Paricular ineres in his quesion in many developing counries and U.S. circa Typical mehod: compue exra percenage of consumpion represenaive agen would require in high-inflaion environmen o be jus as well off (uiliy as in low-inflaion environmen (wihou he consumpion compensaion Applied o seady sae, compue ζ such ha "BAD" POLICY "BAD" POLICY "GOOD" POLICY "GOOD" POLICY ((1 + ς, (, u c n u c n = 1 β 1 β Consumpion equivalens Sepember 27, WELFARE COSTS OF INFLATION Cooley and Hansen resuls Define good policy benchmark as Friedman Rule 100ζ A common benchmark resul in he lieraure i.e., Lucas (2000, Lagos and Wrigh (2005, ohers compare wih i 100ζ Sepember 27,
6 WELFARE COSTS OF VARIABLE POLICY No sudied by Cooley and Hansen Typical mehod: compue exra percenage of consumpion represenaive agen would require in variable-money-growh environmen o be jus as well off (uiliy as in consanmoney-growh environmen (wihou he consumpion compensaion T = 0 Applied o dynamics, compue ζ such ha u c VARIABLE POLICY VARIABLE POLICY β u + c n = ((1 ς, CONSTANT POLICY CONSTANT POLICY (, n 1 β Sepember 27, WELFARE COSTS OF VARIABLE POLICY No sudied by Cooley and Hansen Typical mehod: compue exra percenage of consumpion represenaive agen would require in variable-money-growh environmen o be jus as well off (uiliy as in consanmoney-growh environmen (wihou he consumpion compensaion T = 0 Applied o dynamics, compue ζ such ha u c VARIABLE POLICY VARIABLE POLICY β u + c n = In pracice, choose T large enough so ha β T 0 ((1 ς, T { } 0 CONSTANT POLICY CONSTANT POLICY (, n 1 β Obain c, n hrough simulaion = CANNOT USE LINEAR APPROXIMATION! Due o cerainy equivalence The whole poin here is o compue welfare losses due o he uncerainy/variabiliy surrounding policy Sepember 27,
7 OTHER ANALYSIS In presence of oher disoring axes (labor- and capialincome, welfare cos of moderae (long-run inflaion abou double Wih oher disoring axes (1991 JMCB Wihou oher disoring axes (1989 AER Also has revenue consequences (consolidaed fiscal-moneary budge basis for Ramsey models ala Lucas and Sokey (1983, Chari and Kehoe (1999 Sepember 27, (s SUMMARY Business cycle dynamics of real variables lile-affeced by exogenous flucuaions in money growh rae No a very srong moneary propagaion mechanism Business cycle dynamics of nominal variables (π, i no in line wih empirical evidence (Froniers chaper Welfare coss of moderae ( 10 percen long-run inflaion 0.4 percen of long-run consumpion Can double if economy is disored by oher axes All semming from (easing he ransacions (CIA fricion New Keynesian models: source of welfare gains from lowering inflaion (reduces relaive-price disorions very differen Long-run upward-sloping Phillips Curve New Keynesian models: emphasis on shor-run Phillips Curve Sepember 27,
8 Moneary Models OTHER GENERAL ISSUES Which asses provide liquidiy services? Money (Some bonds? Which o include in CIA consrain? Timing? Do money/asse markes mee before or afer goods markes? Carlsrom and Fuers (2001 JME demonsrae precise iming of moneary models can be crucial for some resuls Money growh rules vs. ineres rae rules? Non-New Keynesian models ypically use money growh rule Bu see Gavin, Kydland, and Pakko (2007 JME for recen example using ineres rae rule New Keynesian models ypically use ineres rae rule Sepember 27,
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