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Kristin Van Gaasbeck and Kevin Salyer
''Taking the Monetary Implications of a Monetary Model Seriously''
( 2007, Vol. 5 No.21 )
It has become common practice in applied monetary economics to posit an interest rate rule as a component of the economic environment. Since the general equilibrium setting imposes a money demand relationship, the interest rate rule implies that the money supply is endogenous. Rarely are the properties of the money supply implied by the model compared to the data. In this paper, we take the monetary implications of a monetary model seriously in a limited participation model that permits both technology and money shocks. We model the money supply as an exogenous Markov process and calibrate the parameters of the Markov process to the data. We then examine whether the model produces an interest rate rule similar to the Taylor rule relationship observed in the data. The model is able to duplicate qualitatively the relationship between inflation and nominal interest implied by the Taylor rule, but fails dramatically to replicate the correlation between nominal interest rates and output.
Keywords: calibration
JEL: E4 - Money and Interest Rates: General
E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit: General
Manuscript Received : Oct 18 2007 Manuscript Accepted : Oct 23 2007

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