Nominal and real rigidities in monetary stochastic dynamic general equilibrium models of the business cycle

The purpose of the present study is to explore the specific contributions of variousnominal and real rigidities in monetary DGE models in a systematic way and ina common framework. I will concentrate on a quite simple model setup in orderto find out the important transmission mechanisms at work. The focus will be onexogenous money growth shocks as the driving force of the business cycle and noton interest rate shocks. The book contains five main chapters. All these chapters are presented in a waythat allows the reader to study them separately. Therefore the building blocks ofthe models will be repeated in every chapter. The first four chapters are concernedwith the question which rigidities are essential to explain actual business cycles whileChapter 6 analyzes optimal monetary policy in a stochastic DGE model.In Chapter 2 the basic model is presented. Prices are set in a staggered wayas in Taylor (1980). The chapter addresses two questions that have not yet beenanswered in the literature. First: Is there a difference between money introducedvia a CIA-constraint or via a MIU-specification? Second: Does it matter how thehousehold?s preferences look like? The answers are yes in both cases. It turns outthat the CIA-model with a standard CRRA utility function can better account forthe business cycle. Thus in Chapter 3 the MIU-setup as well as GHH preferenceswill be discarded. But the model will be augmented by capital accumulation considerations.The chapter considers instead the implications of the price setting scheme:Taylor pricing is compared to Calvo pricing. It turns out that the failure of the basicmodel to generate persistent output responses is due to Taylor type price staggering.The model version with Calvo pricing can account quite well for the empiricalimpulse responses, confirming the results of Kiley (2002) in a more general setup.Chapter 4 considers the role of habits in consumption. While this feature hasalready been analyzed by others, e.g. Christiano, Eichenbaum and Evans (2003),there is no study that tries to figure out the specific effects of habit formation inisolation. In addition, related studies use Calvo pricing. Here the MIU-model withTaylor price staggering will again be considered in order to examine whether thiscan improve the model with respect to its ability to create persistence in output.Unfortunately only the response of consumption to a money growth shock can beimproved. For a high enough value of the habit persistence parameter consumptioncan even be hump-shaped, as it is empirically (see Figure 1.4).Chapter 5 presents a model with Taylor wage staggering and adjustment costsof price changes as in Rotemberg (1982). It turns out that this specific combinationis important to get persistent output responses to a money growth shock. Whenusing also Taylor price staggering the result breaks down and output and prices willnot be persistent. Sticky prices through adjustment costs of prices operate similaras sticky prices under Calvo pricing. When they interact with adjustment costs ofcapital they can even strengthen the persistence in output. In the absence of thecosts for adjusting the capital stock there are only very moderate effects on output.Chapter 6 goes a step further. Here the question is not whether a monetarystochastic DGE model can generate persistence but whether a central bank canstabilize the price level as claimed by King and Wolman (1999). The analysis buildsupon the framework used before: the household maximizes life-time utility and firmsmaximize profits. The central bank acts as a social planner that takes into accountthe optimizing behavior of the household and the firms. Maximizing welfare is thenequivalent to maximizing utility of the representative household. It is shown thatthe result of King and Wolman does not hold under a different specification of thepreference function so that in general the monetary authority will not be successfulin completely stabilizing the price level, as is also observed empirically. Chapter 7 summarizes the main findings and gives some suggestions for future research while Chapter 1 discusses briefly important advances in macroeconomic theory as well as in empirical methods to characterize the business cycle.