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The purpose of the present study is to explore the specific contributions of various

nominal and real rigidities in monetary DGE models in a systematic way and in

a common framework. I will concentrate on a quite simple model setup in order

to find out the important transmission mechanisms at work. The focus will be on

exogenous money growth shocks as the driving force of the business cycle and not

on interest rate shocks. The book contains five main chapters. All these chapters are presented in a way

that allows the reader to study them separately. Therefore the building blocks of

the models will be repeated in every chapter. The first four chapters are concerned

with the question which rigidities are essential to explain actual business cycles while

Chapter 6 analyzes optimal monetary policy in a stochastic DGE model.

In Chapter 2 the basic model is presented. Prices are set in a staggered way

as in Taylor (1980). The chapter addresses two questions that have not yet been

answered in the literature. First: Is there a difference between money introduced

via a CIA-constraint or via a MIU-specification? Second: Does it matter how the

household’s preferences look like? The answers are yes in both cases. It turns out

that the CIA-model with a standard CRRA utility function can better account for

the business cycle. Thus in Chapter 3 the MIU-setup as well as GHH preferences

will be discarded. But the model will be augmented by capital accumulation considerations.

The chapter considers instead the implications of the price setting scheme:

Taylor pricing is compared to Calvo pricing. It turns out that the failure of the basic

model to generate persistent output responses is due to Taylor type price staggering.

The model version with Calvo pricing can account quite well for the empirical

impulse responses, confirming the results of Kiley (2002) in a more general setup.

Chapter 4 considers the role of habits in consumption. While this feature has

already been analyzed by others, e.g. Christiano, Eichenbaum and Evans (2003),

there is no study that tries to figure out the specific effects of habit formation in

isolation. In addition, related studies use Calvo pricing. Here the MIU-model with

Taylor price staggering will again be considered in order to examine whether this

can improve the model with respect to its ability to create persistence in output.

Unfortunately only the response of consumption to a money growth shock can be

improved. For a high enough value of the habit persistence parameter consumption

can even be hump-shaped, as it is empirically (see Figure 1.4).

Chapter 5 presents a model with Taylor wage staggering and adjustment costs

of price changes as in Rotemberg (1982). It turns out that this specific combination

is important to get persistent output responses to a money growth shock. When

using also Taylor price staggering the result breaks down and output and prices will

not be persistent. Sticky prices through adjustment costs of prices operate similar

as sticky prices under Calvo pricing. When they interact with adjustment costs of

capital they can even strengthen the persistence in output. In the absence of the

costs for adjusting the capital stock there are only very moderate effects on output.

Chapter 6 goes a step further. Here the question is not whether a monetary

stochastic DGE model can generate persistence but whether a central bank can

stabilize the price level as claimed by King and Wolman (1999). The analysis builds

upon the framework used before: the household maximizes life-time utility and firms

maximize profits. The central bank acts as a social planner that takes into account

the optimizing behavior of the household and the firms. Maximizing welfare is then

equivalent to maximizing utility of the representative household. It is shown that

the result of King and Wolman does not hold under a different specification of the

preference function so that in general the monetary authority will not be successful

in completely stabilizing the price level, as is also observed empirically. Chapter 7 summarizes the main findings and gives some suggestions for future research while Chapter 1 discusses briefly important advances in macroeconomic theory as well as in empirical methods to characterize the business cycle.