Monetary aggregates, financial intermediate and the business cycle

Hao Hong ()
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Hao Hong: Cardiff Business School

No E2011/16, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: This paper explains and evaluates the transmissions and effectiveness of monetary policy shock in a simple Cash-in-Advance (CIA) economy with financial intermediates. Lucas-Fuerst's (1992) limited participation CIA models are able to explain decreasing nominal interest rates and increasing real economic activity with monetary expansion through limited participation monetary shock and the cost channel of monetary policy. Calvo's (1983) sticky price monetary model examines the real effects of money injections through firms price setting behaviour, but it fails to generate a negative correlation between nominal interest rates and money growth rate, which has been observed in the data. This paper employs McCandless (2008) financial intermediates CIA model to explain the transmissions and impacts of monetary shocks. The model does not request limited participation monetary shock or Keynesian type of sticky price/wage, to examine the lower nominal interest rate and increasing real economic activity with monetary expansion. By extending the model with Stockman's (1981) CIA constraint, it is able to account for both positive response of consumption subject to monetary innovations, which has been found in Leeper et al. (1996) and the positive correlation between output and consumption which has been observed in the data.

Keywords: Monetary business cycle; financial intermediate; cash-in-advance model (search for similar items in EconPapers)
JEL-codes: E44 E52 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2011-06
New Economics Papers: this item is included in nep-cba, nep-dge, nep-fdg, nep-mac and nep-mon
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