The Quantitative Analytics of the Basic Neomonetarist Model

This 1995 Journal of Money, Credit and Banking paper (circulated as NBER Working Paper 5046, February 1995) builds what the author calls a “Neomonetarist” model – a hybrid that keeps a Real Business Cycle model’s real side (optimizing households and firms, investment adjustment costs, increasing returns to scale) as intact as possible while grafting on Calvo-style sticky prices, imperfect competition, and a new, flexible way of letting a firm’s desired markup vary with its own relative output (a demand “aggregator” that nests but generalizes the constant-elasticity case). The paper’s central methodological contribution is a new approximation technique – useful whenever one state variable (here, the price level) adjusts quickly while another (here, capital) adjusts slowly – that lets the model’s short-run dynamics be solved in closed form. Its central substantive results are, first, that the macroeconomic speed at which the aggregate price level adjusts to a monetary shock is governed not just by how often individual firms get to reset prices, but by the economy’s degree of “real rigidity” in the Ball and Romer (1990) sense, so that strong real rigidity (which makes sticky prices more plausible at the firm level) simultaneously makes the aggregate economy adjust more slowly than the firm-level price-change frequency alone would suggest; and second, a deliberately counterintuitive finding that even after adding investment adjustment costs – which are specifically needed to let the real interest rate diverge from the marginal product of capital – plausibly calibrated parameter values imply that a permanent monetary expansion raises, rather than lowers, the real interest rate, unless the aggregate price level’s half-life of adjustment is under about 50 days. The paper reads this as a challenge to the standard downward-sloping-IS-curve intuition taught in intermediate macroeconomics, suggesting that any real-world tendency for the real rate to fall after a monetary expansion may need to be modeled as a disequilibrium phenomenon (output temporarily off the economy’s IS-curve relationship) rather than as a feature of the curve itself.

Miles S. Kimball | Macro Paper Warehouse

The Quantitative Analytics of the Basic Neomonetarist Model