The theoretical framework of monetary policy revisited

Hiona Balfoussia, Sophocles Brissimis and Manthos Delis ()

MPRA Paper from University Library of Munich, Germany

Abstract: The three-equation New-Keynesian model advocated by Woodford (2003) as a self-contained system on which to base monetary policy analysis is shown to be inconsistent in the sense that its long-run static equilibrium solution implies that the interest rate is determined from two of the system’s equations, while the price level is left undetermined. The inconsistency is remedied by replacing the Taylor rule with a standard money demand equation. The modified system is seen to possess the key properties of monetarist theory for the long run, i.e. monetary neutrality with respect to real output and the real interest rate and proportionality between money and prices. Both the modified and the original New-Keynesian models are estimated on US data and their dynamic properties are examined by impulse response analysis. Our research suggests that the economic and monetary analysis of the European Central Bank could be unified into a single framework.

Keywords: Monetary theory; Central banking; New-Keynesian model; Impulse response analysis (search for similar items in EconPapers)
JEL-codes: E40 E47 E52 E58 (search for similar items in EconPapers)
Date: 2011-07-13
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Working Paper: The theoretical framework of monetary policy revisited (2011)
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