Embodied Technology and Money Shocks

1. Embodied Technology and Money Shocks Lumps, Bumps, and Humps

2. Money, Output, and Prices in the long Run • The long run correlation between money growth and inflation is nearly one. • Lucas (1980) • Barro (1991) • Rolnick/Weber (1994)

3. Money, Output, and Prices in the long Run • The long run correlation between money growth and GDP growth is nearly zero • Geweke (1986) • Poirier (1991)

4. Money and Output in the Short Run • The contemporaneous correlation between is positive. • Further, the dynamic correlations are also positive for both leads and lags • Cooley/Cho (1993)

5. Money and Output in the Short Run

6. VAR Analysis (Christiano,Eichenbaum,Evans - 1998 ) • ‘Y’ is a measure of real economic activity • ‘X’ is a measure of monetary policy

7. Impulse Responses: Humps

8. Impulse Responses: Humps

9. Impulse Responses: Humps

10. Modeling Money • Any model based on the quantity theory with flexible prices can explain long run correlations between money/output/prices MV = PY

11. Modeling Money • The positive contemporaneous correlation are also easily reproducible by introducing various market frictions • Fixed nominal wage contracts • Short run price frictions • Financial market frictions

12. Explaining the Humps with Lumps and Bumps • Existing frameworks have difficulty explaining the dynamic effects of money • Existing frameworks rely on a “generic” treatment of capital equipment

13. Explaining the Humps with Lumps and Bumps • At the plant level, capital investment is very “lumpy” – occurring is short bursts • Over a 15 year period, 25% of a plant’s capital expenditure take place within one year – 50% occurs within a contiguous 3 year period (Doms/Dunne – 1993) • Further, with rapidly evolving technology, compatibility issues arise between old and new machines

14. Modeling “Vintage Capital” • New capital equipment embodies the latest technology which makes new capital incompatible with old capital • Therefore, capital must be indexed by age

15. Solving the Model • The model can be solved using standard methods for solving dynamic systems • Linearize the system around the steady state • Solve for the stable saddle path using linear difference equation techniques • Adding the vintage structure, however, greatly increases the complexity of the system • A “standard” treatment would involve a system of 6 equations/unknowns (first order) • A vintage model with 8 vintage of capital involves a system of 49 equations (8th order)

16. Results • Capital is assumed to have a lifetime of 8 periods (two years) • An experiment is run in which a monetary innovation of one standard deviation is introduced • The model can reproduce the hump shaped pattern found in the data. However, the model tends to exhibit excessive volatility.

17. References • Barro, Robert, “Economic Growth in a Cross-Section of Countries", 1991, QJE • Christiano, L., M. Eichenbaum, C. Evans (1998), “Monetary Policy Shocks: What Have We Learned and to What End?”, Handbook of Macroeconomics • Cho, J.O. & Cooley, T.F., 1991. "The Business Cycle with Nominal Contracts," RCER Working Papers • Doms M. and Timothy Dunne (1993), "Capital Adjustment Patterns in Manufacturing Plants; Lumps and Bumps" • Geweke, John (1986),"The Super neutrality of Money in the United States: An Interpretation of the Evidence“, Econometrica • Lucas, Robert (1980), “Two Illustrations of the Quantity Theory of Money”, American Economic Review, 70 • McCandless, George and Warren Weber (1995), “Some Monetary Facts”, Federal Reserve of Minneapolis Quarterly Review • Poirier, Dale (1991), “A Bayesian View of Nominal Money and Real Output Through a New Classical Macroeconomic Window”, Journal of Business & Economic Statistics