Ebook Endogenous Money or Sticky Wages: A Bayesian Approach
In a classical model economy, real variables are independent of monetary policy. However, monetary policy plays an important role in explaining the behavior of nominal variables, such as prices. As pointed out by Ireland (2003), under a Taylor-type interest rate rule, money supply and nominal interest rate become endogenous, at least most if not all, and the effects of changes in monetary policy can be interpreted plausibly as how nominal variables respond to real variables, not the other way around.
On the other hand, nominal rigidities provide a channel through which nominal variables drive movements in real variables. Ireland (2003) uses maximum likelihood to estimate a structural model of endogenous money with Rotemberg-type (quadratic costs) sticky prices (Rotemberg, 1982), and suggests that the nominal price rigidity, over and above endogenous money, plays a role in accounting for the key features of postwar US data.
Recently, the New Keynesian model with both Calvo-type sticky prices and sticky wages (Erceg et al., 2000) has become the framework in the literature in monetary policy analysis (e.g. Giannoni and Woodford, 2003). The model has also been used in studying the persistence of effects of monetary policy shocks. For instance, both studies by Huang and Liu (2002) and Christiano et al. (2005) suggest that it is the staggered wage, not staggered price, which plays an important role in generating the observed inertia in inflation and persistent output movements in response to a monetary policy shock.
The objective of this paper is to investigate whether a dynamic New Keynesian model without nominal wage rigidities, but with an augmented Taylor-type interest rate rule, is capable of explaining the joint behavior of nominal and real variables and their connection to monetary policy. In other words, the paper aims to find out whether endogenous money, sticky wages, or some combination of the two, are necessary features in a dynamic New Keynesian model in explaining the correlations between nominal and real variables in postwar US data. To do so, we incorporate real balances and staggered wage contracts into a dynamic New Keynesian model. We employ the Bayesian technique to estimate the structural model, using postwar US data from 1959:01 to 2008:02. We then compare the estimated structural models of endogenous money with and without staggered wage contracts. We conclude that both endogenous money and sticky wages are necessary features in a dynamic New Keynesian model in explaining the variation in key macroeconomic variables, both nominal and real.
The remainder of the paper is organized as follows. Section 2 lays out the structural model. Section 3 discusses the prior and posterior parameters and the robustness of the estimation results. Section 4 answers the question asked in the present paper, while Section 5 concludes.
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