Inside Money, Nominal Rigidities and the US Business Cycle

Research Proposal - Presentation

Vaclav France

Statement of the Problem (1)  My research is motivated by a structural change in the world economy that happened in 2007 (the beginning of the Financial Crisis) Prior 2007 – tranquil era 1990-2007       Long expansions and short and mild recessions 2001 recession – the 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 cycles existed? .

Woodford (2010) .Statement of the Problem (2)  However. Nonstandard policy used (“quantitative easing“). the Financial Crisis started developing  Similar to the 2001 recession. but the magnitude of the latter was much 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. but it is likely to be ineffective according to Curdia. in 2007.

but a void still exists (as explained later). .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. This research seeks to fill that void.

Their model will serve as a benchmark for my research.Literature Review (1)  Why to study inside money and nominal rigidities? Why not other phenomena? (e.g. (2005) confirm importance of nominal rigidities for the persistance of a shock to monetary. . nominal rigidities & endogenous money supply) Yun (1996) and Ireland (2003):   “The stickiness of prices plays dominant role above money supply endogeneity“  Christiano et al.

Chari et al. Kejak (2004) confirm importance of inside money for explaining dynamic behaviour of BC variables  However. (1995) and Gilmann.Literature Review (2)  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   .

(1995) model  Inside Money    Created within an economy Its net sum is zero within an economy Demand deposits Chari et al. (1995) model . 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.Methodology (Outside vs.

commercial banks and the central bank Households   Supply labor and capital to the final goods and the banking sector & decide what fraction of their currency holdings translates into demand deposits to minimize their transactional cost Use capital and labor to produce final good Use currency from households to produce demand deposits for consumers and loans for firms Determines monetary base (drops money from helicopter)  Firms   Commercial banks   Central bank  . firms.Methodology (The Model)  Players in the game: Households.

.zt. (1995) assume the following production function of demand deposits       h(kbt.lbt.Methodology (1st Modification)  Chari et al.xbt) = abxbt(lbtkbtα(ztnbt)1-α)ξet1-ξ xbt random shock to production of demand = ab(lbtkbtα(ztnbt)1-α)ξet1-ξ kbt capital in the banking sector lbt length of the workweek the banking sector nbt number of workers in the banking sector et excess of reserves (deposits plus cash injections of the central bank minus required reserves) zt economy wide technology parameter  I propose the following modification   h( which follows auto-regresive process .lbt.

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 (τ)    Not realistic I will allow for a higher degree of flexibility and possibly dependence of τ on output or price level τ as another tool of monetary policy .

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 .

It may be considered for requisite funding .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.

Christiano. Nominal rigidities and the dynamic effects of a shock to monetary policy. Economic Inquiry. Christiano.. M. Eichenbaum. L. 1-45. V. Gillman. & Kejak. & Woodford. L. Inside money. & Evans. 113(1). February). M. (1995)... 091016). M.. outside money and short term interest rates (Working Paper Series.. C. L. 42(3). . Macroeconomic Issues No. Columbia University. The central bank balance sheet as an instrument of monetary policy (Discussion Papers No. (2010). July). M. V. (2004. (2005. M. 518-533. Department of Economics. J. Federal Reserve Bank of Chicago.Bibliography (1) Chari.. 95-13). & Eichenbaum. Curdia. J. The demand for bank reserves and other monetary aggregates. Journal of Political Economy.

345-370. Schorfheide. N. Journal of Applied Econometrics. Nominal price rigidity. T. 15(6). 1623-1648. 645-670. (2000). November). Journal of Monetary Economics. Loss function-based evaluation of DSGE models. Endogenous money or sticky prices? Journal of Monetary Economics. P. and business cycles. (2003. (1996. 37(2-3). F. Yun. April). .Bibliography (2) Ireland. money supply endogeneity. 50(8).