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8/8/2019 Research Proposal Presentation 2
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Inside Money, Nominal Rigiditiesand the US Business Cycle
Research Proposal - Presentation
Vaclav France
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Statement of the Problem (1)
My research is motivated by a structural change in the worldeconomy that happened in 2007 (the beginning of the
Financial Crisis)
Prior 2007tranquil era 1990-2007
Long expansions and short and mild recessions
2001 recessionthe shortest recession in US history
Stability was the prevailing feature of that era
Business cycle fluctuation did not attract much attention
Was the world seeing the start of a new economy, where no cyclesexisted?
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Statement of the Problem (2)
However, in 2007, the Financial Crisis started developing
Similar to the 2001 recession, but the magnitude of the latter wasmuch more than the former
It changed the economic environment a lot Instability of our economies is a serious problem now
It turned the attention to business cycles again
Efficiency of monetary policy unclear. Interest rates plummed to their zero
lower bound. Nonstandard policy used (quantitative easing), but it is likelyto be ineffective according to Curdia, Woodford (2010)
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Research Questions
What shocks are the most important source of fluctuations?
Financial shocks? ,or
Shocks to technology?
What is the role of monetary policy in smoothing out
business cycles?
There is much literature on these themes, but a void still exists
(as explained later). This research seeks to fill that void.
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Literature Review (1)
Why to study inside money and nominal rigidities? Why not
other phenomena? (e.g. nominal rigidities & endogenousmoney supply)
Yun (1996) and Ireland (2003): The stickiness of prices plays dominant role above money
supply endogeneity
Christiano et al. (2005) confirm importance of nominal
rigidities for the persistance of a shock to monetary. Theirmodel will serve as a benchmark for my research.
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Literature Review (2)
Chari et al. (1995) and Gilmann, Kejak (2004) confirm
importance of inside money for explaining dynamicbehaviour of BC variables
However, Chari et al. (1995) model can be extended in a few
ways Allow for shocks to production of inside money
Incorporate monopolistic competition into final goods sector
(necessary condition for rigidity of prices)
Relax assumption of constant required rate of reserves
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Methodology (Outside vs. Inside Money)
Outside Money
Created outside an economy and exogenously injected into
economy
Falls like manna from heaven Its net sum is positive in an economy
Currency in Chari et al. (1995) model
Inside Money
Created within an economy
Its net sum is zero within an economy
Demand deposits Chari et al. (1995) model
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Methodology (1st Modification) Chari et al. (1995) assume the following production function of demand
deposits
h(kbt
,lbt
,nbt
,et,z
t) = a
b(l
btk
bt(z
tn
bt)1-)e
t1-
kbt
capital in the banking sector
lbt
length of the workweek the banking sector
nbt
number of workers in the banking sector
etexcess of reserves (deposits plus cash injections of the central
bank minus required reserves) z
teconomy wide technology parameter
I propose the following modification
h(kbt
,lbt
,nbt
,et,z
t,,x
bt) = a
bx
bt(l
btk
bt(z
tn
bt)1-)e
t1-
xbt random shock to production of demand deposits, which followsauto-regresive process
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Methodology (2nd & 3rd Modification) Introduction of monopolistic competition into the final goods sector
Necessary condition for rigidity of prices Rigidities necessary for monetary policy to work It will enable me to decide what frictions are more important
(financial or output market frictions)
Relaxing assumption of fixed minimum required rate of reserves ()
Not realistic I will allow for a higher degree of flexibility and possibly
dependence of on output or price level as another tool of monetary policy
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Methodology (Data & Estimation)
I will use the US business cycle data because of two reasons Better availability of data US economy is big and relatively closed (easier modeling
strategy)
Bayesian method of estimating DSGE models will be used,
see Schofrheide (2000) More sophisticated estimation method It indicates mis-specification of the model
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Conclusion
This research seeks to address an issue that is of
critical importance today
It fills a void in the available economic literature as it
amends existing model of business cycle.
It may be considered for requisite funding
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Bibliography (1)
Chari, V., Christiano, L. J., & Eichenbaum, M. (1995).Inside money, outside money and
short term interest rates (Working Paper Series, Macroeconomic Issues No. 95-13).
Federal Reserve Bank of Chicago.
Christiano, L. J., Eichenbaum, M., & Evans, C. L. (2005, February).Nominal rigiditiesand the dynamic effects of a shock to monetary policy. Journal of Political Economy,
113(1), 1-45.
Curdia, V., & Woodford, M. (2010). The central bank balance sheet as an instrument of monetary
policy(Discussion Papers No. 091016). Columbia University, Department of Economics.
Gillman, M., & Kejak, M. (2004, July). The demand for bank reserves and other monetary aggregates.
Economic Inquiry, 42(3), 518-533.
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Bibliography (2)
Ireland, P. N. (2003, November). Endogenous money or sticky prices?Journal of
Monetary Economics, 50(8), 1623-1648.
Schorfheide, F. (2000). Loss function-based evaluation of DSGE models. Journal ofApplied Econometrics, 15(6), 645-670.
Yun, T. (1996, April).Nominal price rigidity, money supply endogeneity, and business cycles.
Journal of Monetary Economics, 37(2-3), 345-370.
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