Monetary Policy and the Monetary Transmission Mechanism

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The purpose of this research is to continue developing an empirically based, dynamic general equilibrium framework for analyzing monetary policy. This effort will have two basic components: to better understand the monetary policy making process itself, and to develop improved models of the links between monetary policy and the performance of the overall economy. The first component seeks to endogenize monetary policy by thinking of it as being determined by a purposeful policy maker who does not have the ability to commit to future actions. This project will investigate the possibility that the take-off of inflation in the 1970s reflects in part the kind of instability that can arise when monetary policy is conducted in the absence of commitment. An important objective of this proposal is to analyze alternative feasible institutional arrangements that could give rise to a more stable monetary policy. The second component of this project focuses on developing improved models of the economy. For an analysis of alternative monetary policy regimes to be persuasive, it must be built upon a sound model. One strand of the proposed research builds on the author's previous work developing a framework for integrating monetary and business cycle phenomena. Specifically, the project will explore various factors that can help account quantitatively for the observation that the price effects of monetary policy disturbances appear to be small, while the output effects are relatively larger. In a third strand of research the investigator will continue his work reconciling the salient characteristics of asset returns with macroeconomic models. This is important because virtually any view about the way money affects the economy assigns a central role to asset markets. The investigator will also explore the possibility that expectational shocks play an important role in the business cycle. Understanding what are the ultimate impulses to the business cycle is likely to be important in any assessment of alternative monetary policies. Finally, the investigator will use financial market data to obtain improved estimates of the exogenous component of monetary policy. Such measures play an important role in efforts to identify the channels by which money affects the economy.