Monetary policy and economic growth: combining short and long run macro analysis

Gomes, Orlando (2006): Monetary policy and economic growth: combining short and long run macro analysis.

Abstract

The new Keynesian monetary policy model studies the response of the inflation – output gap trade-off to policy decisions taken by the Central Bank, concerning the nominal interest rate time trajectory. Under an optimal setup, this model displays a saddle-path stable equilibrium and, if the stable trajectory is followed, the steady state is characterized by an inflation rate that coincides with the selected inflation target. A high inflation target has positive effects over the rise of effective output relatively to its potential level (the monetary policy problem captures this effect), but it has a perverse impact over investment decisions (the referred problem does not capture this effect, taking it as granted). This second relation can be understood by associating to the first macro model a second setup, which takes consumption and investment decisions, i.e., by considering a long term growth setup. The link between the two is present on the impact of inflation over investment decisions. With this integrated framework one is able to simultaneously study short and long-run macroeconomic phenomena and to jointly analyze the behaviour of nominal and real aggregates. The most important results consist on the determination of an optimal inflation target and on the consideration of short term supply shocks as having a long-run impact producing business cycles.

• Item Type: MPRA Paper
• Institution: Escola Superior de Comunicação Social - Instituto Politécnico de Lisboa
• Language: English
• Keywords: Monetary policy; Economic growth; Inflation targeting; Output gap
• Subjects: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C61 - Optimization Techniques ; Programming Models ; Dynamic Analysis; O - Economic Development, Innovation, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O41 - One, Two, and Multisector Growth Models; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

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