The role of money in a business cycle model

Finn Kydland

No 23, Discussion Paper / Institute for Empirical Macroeconomics from Federal Reserve Bank of Minneapolis

Abstract: Two mechanisms are considered through which money can play a role in a real business cycle model. One is in the form of aggregate price surprises when there is heterogeneity across individuals or groups of individuals (islands). These shocks affect the accuracy of information about real compensation that can be extracted from observed wage rates. Another, perhaps complementary, mechanism is that the amount of desired liquidity services varies over the cycle due to a trade-off between real money and leisure. This mechanism leads to price fluctuations even when the nominal money stock does not fluctuate. As is the case for the U.S. economy over the postwar period, the price level is then countercyclical. A key finding is that with neither mechanism do nominal shocks account for more than a small amount of variability in real output and in hours worked. Indeed, output variability may very well be lower the larger the variance of price surprises is.

Keywords: Business cycles; Money (search for similar items in EconPapers)
Date: 1989
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