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The long-run real effects of monetary policy: Keynesian predictions from a neoclassical model

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  • Marco A. Espinosa-Vega
  • Steven Russell

Abstract

In this paper we integrate Diamond's (1965) model of neoclassical production and capital with Wallace's (1984) model of monetary policy in order to study the real effects of two types of monetary policy actions: open market operations and changes in reserve requirements. We show that a permanent easing of open market or reserve policy can produce permanent increases in both the inflation rate and the level (but not the growth rate) of output. We also describe conditions under which the effects of these policies on real interest rates and output can be large relative to their effects on the rate of inflation. When we compare the effects of the two types of policies we find that open market operations are the policy tool that minimizes the change in the inflation rate necessary to achieve a given change in the level of output.

Suggested Citation

  • Marco A. Espinosa-Vega & Steven Russell, 1998. "The long-run real effects of monetary policy: Keynesian predictions from a neoclassical model," FRB Atlanta Working Paper 98-6, Federal Reserve Bank of Atlanta.
    • Handle: RePEc:fip:fedawp:98-6
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    References listed on IDEAS

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    Cited by:

    1. Christopher J. Neely & David E. Rapach, 2008. "Real interest rate persistence: evidence and implications," Review, Federal Reserve Bank of St. Louis, vol. 90(Nov), pages 609-642.
    2. Sonali Das & Rangan Gupta & Patrick Kanda & Monique Reid & Christian Tipoy & Mulatu Zerihun, 2014. "Real interest rate persistence in South Africa: evidence and implications," Economic Change and Restructuring, Springer, vol. 47(1), pages 41-62, February.
    3. Frederick H. Wallace & Gary L. Shelley, 2004. "Long Run Neutrality and Superneutrality of Money: Aggregate and Sectoral Tests for Nicaragua," Macroeconomics 0402004, University Library of Munich, Germany.
    4. Leopold von Thadden, 2004. "Active monetary policy, passive fiscal policy and the value of pure debt: some further monetarist arithmetic," Money Macro and Finance (MMF) Research Group Conference 2003 108, Money Macro and Finance Research Group.
    5. McAndrews, James & Roberds, William, 1999. "A General Equilibrium Analysis of Check Float," Journal of Financial Intermediation, Elsevier, vol. 8(4), pages 353-377, October.
    6. Marco A. Espinosa-Vega & Steven Russell, 2001. "Stability of steady states in a model of pleasant monetarist arithmetic," FRB Atlanta Working Paper 2001-20, Federal Reserve Bank of Atlanta.
    7. Franz R. Hahn & Peter Mooslechner, 1999. "Zur Fundierung des Designs des Europäischen Zentralbanksystems," WIFO Monatsberichte (monthly reports), WIFO, vol. 72(1), pages 49-60, January.
    8. Cothren, Richard, 2006. "A model of optimal legal restrictions and open market operations," Journal of Macroeconomics, Elsevier, vol. 28(3), pages 480-492, September.
    9. Robert Hiscock & Jagdish Handa, 2013. "Long-run neutrality and superneutrality of money in South American economies," Applied Financial Economics, Taylor & Francis Journals, vol. 23(9), pages 739-747, May.

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    Keynesian economics; Monetary policy;

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