DP1630 Money in a Real Business Cycle Model

Author(s): Roger E A Farmer
Publication Date: April 1997
Keyword(s): Businesss Fluctuations, Indeterminacy, Sunspots
JEL(s): E00, E4
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1630

This paper constructs a real business cycle model in which real money balances yield utility. We calibrate the model to fit the first moments of US data and simulate a set of impulse response functions that are generated by the model for GDP, the rate of interest, money growth and real balances. These theoretical impulse responses are compared with actual impulse responses from US data. The model does a reasonably good job of capturing the dynamic interactions of money and real variables in US data. It differs from most existing approaches by choosing a parameterization of utility for which the model admits the existence of indeterminate equilibria. It is argued that this fact is critical in explaining the monetary propagation mechanism.