Research Proposal Presentation 2

8/8/2019 Research Proposal Presentation 2

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Inside Money, Nominal Rigiditiesand the US Business Cycle

Research Proposal - Presentation

Vaclav France


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Statement of the Problem (1)

My research is motivated by a structural change in the worldeconomy that happened in 2007 (the beginning of the

Financial Crisis)

Prior 2007tranquil era 1990-2007

Long expansions and short and mild recessions

2001 recessionthe 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 cyclesexisted?


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Statement of the Problem (2)

However, in 2007, the Financial Crisis started developing

Similar to the 2001 recession, but the magnitude of the latter wasmuch 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. Nonstandard policy used (quantitative easing), but it is likelyto be ineffective according to Curdia, Woodford (2010)


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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, but a void still exists

(as explained later). This research seeks to fill that void.


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Literature Review (1)

Why to study inside money and nominal rigidities? Why not

other phenomena? (e.g. nominal rigidities & endogenousmoney supply)

Yun (1996) and Ireland (2003): The stickiness of prices plays dominant role above money

supply endogeneity

Christiano et al. (2005) confirm importance of nominal

rigidities for the persistance of a shock to monetary. Theirmodel will serve as a benchmark for my research.


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Literature Review (2)

Chari et al. (1995) and Gilmann, Kejak (2004) confirm

importance of inside money for explaining dynamicbehaviour of BC variables

However, 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


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Methodology (Outside vs. 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. (1995) model

Inside Money

Created within an economy

Its net sum is zero within an economy

Demand deposits Chari et al. (1995) model


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Methodology (1st Modification) Chari et al. (1995) assume the following production function of demand

deposits

h(kbt

,lbt

,nbt

,et,z

t) = a

b(l

btk

bt(z

tn

bt)1-)e

t1-

kbt

capital in the banking sector

lbt

length of the workweek the banking sector

nbt

number of workers in the banking sector

etexcess of reserves (deposits plus cash injections of the central

bank minus required reserves) z

teconomy wide technology parameter

I propose the following modification

h(kbt

,lbt

,nbt

,et,z

t,,x

bt) = a

bx

bt(l

btk

bt(z

tn

bt)1-)e

t1-

xbt random shock to production of demand deposits, which followsauto-regresive process


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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 ()

Not realistic I will allow for a higher degree of flexibility and possibly

dependence of on output or price level as another tool of monetary policy


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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


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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.

It may be considered for requisite funding


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Bibliography (1)

Chari, V., Christiano, L. J., & Eichenbaum, M. (1995).Inside money, outside money and

short term interest rates (Working Paper Series, Macroeconomic Issues No. 95-13).

Federal Reserve Bank of Chicago.

Christiano, L. J., Eichenbaum, M., & Evans, C. L. (2005, February).Nominal rigiditiesand the dynamic effects of a shock to monetary policy. Journal of Political Economy,

113(1), 1-45.

Curdia, V., & Woodford, M. (2010). The central bank balance sheet as an instrument of monetary

policy(Discussion Papers No. 091016). Columbia University, Department of Economics.

Gillman, M., & Kejak, M. (2004, July). The demand for bank reserves and other monetary aggregates.

Economic Inquiry, 42(3), 518-533.


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Bibliography (2)

Ireland, P. N. (2003, November). Endogenous money or sticky prices?Journal of

Monetary Economics, 50(8), 1623-1648.

Schorfheide, F. (2000). Loss function-based evaluation of DSGE models. Journal ofApplied Econometrics, 15(6), 645-670.

Yun, T. (1996, April).Nominal price rigidity, money supply endogeneity, and business cycles.

Journal of Monetary Economics, 37(2-3), 345-370.

Research Proposal Presentation 2

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