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Monetary business cycle accounting

Roman Sustek
- 01 Oct 2011 - 
- Vol. 14, Iss: 4, pp 592-612
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TLDR
In this article, the authors investigated the importance of various types of distortions for inflation and nominal interest rate dynamics by extending business cycle accounting to monetary models and showed that distortions generating movements in TFP and wedges in equilibrium conditions for asset markets are essential.
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This article is published in Review of Economic Dynamics.The article was published on 2011-10-01 and is currently open access. It has received 41 citations till now. The article focuses on the topics: Business cycle accounting & Nominal interest rate.

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Citations
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ReportDOI

Housing dynamics over the business cycle

TL;DR: In this paper, a fully-amortizing mortgages and an estimated process for nominal interest rates into a standard model aligns the theory with the observations on starts; one-period loans are insufficient to generate the lead.
Journal ArticleDOI

The anatomy of standard DSGE models with financial frictions

TL;DR: The authors compare two standard extensions to the New Keynesian framework that feature financial frictions, and find that the business cycle properties of the external finance premium framework are more in line with empirical evidence.
Journal ArticleDOI

Mortgages and Monetary Policy

TL;DR: In this paper, the authors evaluated the effect of monetary policy on the cost of new mortgage borrowing and the value of payments on outstanding debt under incomplete asset markets and found that higher, persistent, inflation benefits homeowners under FRMs, but hurts them under ARMs.
Book ChapterDOI

Accounting for Business Cycles

TL;DR: In this article, the authors compare the business cycle accounting method proposed by Chari et al. (2006) and apply it to compare the Great Recession across OECD countries as well as to the recessions of the 1980s in these countries.
References
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Journal ArticleDOI

Staggered prices in a utility-maximizing framework

TL;DR: In this article, the authors developed a model of staggered prices along the lines of Phelps (1978) and Taylor (1979, 1980), but utilizing an analytically more tractable price-setting technology.
Journal ArticleDOI

Discretion versus policy rules in practice

TL;DR: In this article, the authors examine how recent econometric policy evaluation research on monetary policy rules can be applied in a practical policymaking environment, and the discussion centers around a hypothetical but representative policy rule much like that advocated in recent research.
Journal ArticleDOI

Postwar U.S. Business Cycles: An Empirical Investigation

TL;DR: In this article, a procedure for representing a times series as the sum of a smoothly varying trend component and a cyclical component is proposed, and the nature of the comovements of the cyclical components of a variety of macroeconomic time series is documented.
Book

Interest and Prices: Foundations of a Theory of Monetary Policy

TL;DR: Woodford as mentioned in this paper proposes a rule-based approach to monetary policy suitable for a world of instant communications and ever more efficient financial markets, arguing that effective monetary policy requires that central banks construct a conscious and articulate account of what they are doing.
Journal ArticleDOI

Shocks and frictions in US business cycles: A Bayesian DSGE approach

TL;DR: In this paper, a dynamic stochastic general equilibrium (DSGE) model for the US economy is proposed, which incorporates many types of real and nominal frictions: sticky nominal price and wage setting, habit formation in consumption, investment adjustment costs, variable capital utilisation and fixed costs in production.
Frequently Asked Questions (18)
Q1. What are the contributions in this paper?

This paper investigates the quantitative importance of various types of frictions for inflation and nominal interest rate dynamics by extending business cycle accounting to monetary models. 

Their analysis is based on a prototype economy that underlies a large class of models used to study the business cycle and the effects of monetary policy. The authors hope that their findings will provide useful information to researchers constructing detailed models with explicit frictions to analyze the business cycle and monetary policy. The authors leave, however, such investigation for future research. The authors have also discussed how the effects of these frictions on inflation and the nominal interest rate can be understood through a pricing function in their prototype economy. 

when the authors leave out the asset market wedge, the nominal interest rate becomes strongly countercyclical with no apparent lead-lag structure. 

Leaving out the labor wedge also deteriorates the observed dynamics, but somewhat preserves its general pattern, leaving the interest rate negatively correlated at leads and positively correlated at most lags. 

The high volatility of the asset market wedge reflects the well-known failure of Euler equations with power utility functions to match asset prices (e.g., Hansen and Singleton, 1983). 

tions that express the deviations of (log yt, log lt, log xt, log ct, log pt, Rt) from steady state as linear functions of the deviations of the state vector (ωt, log pt−1, Rt−1, log kt) from steady state. 

the efficiency and asset market wedges are both necessary, and to some extent also sufficient, for generating the observed lead-lag pattern of the two nominal variables. 

Their findings suggest that such models should, first and foremost, include frictions that manifest themselves as efficiency and asset market wedges. 

Starting from p−1, R−1, and k0 for 1959.Q1, these decision rules and pricing functions are used, together with ωdt (the vector of realized wedges obtained using the procedure of Section 4.3), to compute the labor wedge component of the data. 

To summarize, the main finding of the decomposition is that from the perspective of their prototype economy, the key frictions behind the observed dynamics of inflation and the nominal interest rate over the business cycle are those that are equivalent to efficiency and asset market wedges. 

And third, the authors use the equilibrium decision rules and pricing functions of the prototype economy to back out the realized wedges from the data. 

In a working-paper version of this paper (Sustek, 2009) the authors also show that a model of inflation dynamics based on capacity utilization and energy price shocks studied by Finn (1996) is equivalent to the prototype model with efficiency wedges. 

Henriksen et al. (2008) show that a business cycle model in which the central bank follows a Taylor rule, and in which the only impulses are TFP shocks, also cannot account for such a feature of the data. 

This procedure isolates the movements in the endogenous variables of the model (and thus also in the data, as movements in all six wedges exactly reproduce the data) due to the distortionary effects of the labor wedge alone. 

The strong positive correlation of the asset market wedge with output documented here, however, reveals systematic failure of the standard Euler equation for bonds to account for the movements in the risk-free rate over the business cycle. 

As the next section shows, the efficiency and asset market wedges are crucial for generating the observed dynamics of the nominal interest rate and inflation over the business cycle. 

The search for the maximum of the likelihood function is implemented using simulated annealing (see Goffe, Ferrier and Rogers, 1994) in order to thoroughly explore the surface of the objective function. 

Here the authors just want to point out that these two wedges are strongly positively correlated with each other, having a coefficient of correlation of 0.53.