Ebook Money, New-Keynesian Macroeconomics and the Business Cycle
Two main competing approaches of the business cycle arose in the eighties: the real Business Cycles theory and the New-Keynesian Macroeconomics. Following the seminal papers of Kydland and Prescott [1982], Long and Plosser [1983] and King, Plosser, and Rebelo [1988], RBC theorists consider economic fluctuations as the optimal responses of economic agents to exogeneous real shocks. The aim of these first models was to explain macroeconomic fluctuations only with technological shocks; demand shocks were unnecessary and nominal shocks were de facto absent from these purely real models. Hénin [1989] noticed some attempts to introduce money in such a flex-price competitive framework: the King and Plosser [1984] model introduces financial intermediation and get some insight on the (inside) money-output correlation when technology shocks occur. Nevertheless, the outside money-output link is missing and no quantitative validation of the model is proposed. Outside money shocks are introduced in a cash-in-advance economy by Cooley and Hansen [1989] (constraint on consumption) and Hairault and Portier [1991a] (constraint on consumption and investment) or in a model with money in the utility function by Hairault and Portier [1991b]. These models do not provide a good description of the money output correlation and are not able to reproduce the shape and level of the real variables impulse responses to monetary shocks for a realistic calibration. King [1990] obtains the triangular shape of the monetary business cycle in a staggered contracts model where money is introduced via a quantitative equation. Nevertheless, this quantitative equation has no microeconomic foundations in the model and no simulated moments are computed. Ambler and Phaneuf [1991] also use staggered contracts in a reduced- form model which provides good approximation of monetary impulse responses, but without explicit microfoundations.
Furthermore, the RBC literature initiated a validation method based upon the ability of the model to mimic some macroeconomic stylized facts by stochastic simulations. On the other hand, the New-Keynesian macroeconomy expanded microfounded macroeconomic models with Keynesian features such as underemployment equilibria, coordination failures, market power, real and nominal rigidities and the importance of nominal shocks in the business cycle.
A first attempt to reconciliate the RBC techniques with these new Keynesian developments relies on the introduction of real rigidities on the labour market, via efficency wages (Danthine and Donaldson [1990a]), risk sharing contracts (Danthine and Donaldson [1990b]) or labour hoarding (Burnside, Eichenbaum, and Rebelo [1990], Fairise and Langot [1992]). Nominal rigidities through wage contracts are introduced by Cho [1990a] and Cho and Cooley [1990]. In an other direction, Rotemberg and Woodford [1989] proposed an oligopolistic competition model with Keynesian features.
Following Kiyotaki [1985], Blanchard and Kiyotaki [1987] and Benassy [1987], the monopolistic competition framework has been widely used to introduce nominal rigidities (staggered contrats or menu costs) and to emphasize the role of demand shocks, and particularly monetary shocks.
We propose in this paper a dynamic monopolistic competition model with nominal rigidities and money in the utility function. As Danthine and Donaldson [1991] pointed out the difficulty of a single model to give an accurate description of both US and European fluctuations, we evaluate the ability of our model to mimic two very different business cycles features, namely the French and US ones.
This model allows us to study the effect of monetary shocks in this theoretical framework and with the validation methods of RBC theorists. We will show that the presence of monetary shocks sharply modifies the behaviour of the model. With two independant shocks, one real, which cannot be measured by the Solow residual in that framework4, and one nominal, the model gives an answer to five empirical puzzles, which were unexplained by traditionnal RBC models, on French data as well as on US data:
- the level of output standard deviation
- the money-output and inflation-output correlation
- the labor productivity-worked hours correlation
- the labor productivity-worked hours relative standard deviation
- the mark-up-output correlation
The ability of our model to reproduce these stylized facts, both for the French and US economy, must be underlined, as their cyclical behaviours are far different. Our model may be considered as a synthesis between the RBC model and the New-Keynesian approach to macroeconomics. The first section of the paper presents the model and its approximated resolution around its stationary steady state. The second section illustrates its qualitative and quantitative cyclical properties on US and French data.
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