ON THE ROLE OF MONEY IN REAL BUSINESS-CYCLE MODELS

Within the equilibrium explanation of business cycles, there are two major classes of models. Real business-cycle models emphasize real factors, such as technological changes, in determining economic fluctuations, while monetary business-cycle models advocate the role of money in generating business cycles. Recent theoretical efforts have attempted to provide a reconciliation by allowing technology to be endogenous. In an empirical model that accounts for endogenous technology, technological changes are statistically significant in determining fluctuations in real activity. In contrast, monetary surprises do not induce significant effects that determine the growth of real industrial output. Nonetheless, anticipated technological advances are endogenous with respect to anticipated changes in the money supply. This endogeneity provides the sole channel through which the effects of monetary policy can be transmitted to real activity. That is, anticipated policy changes have long-lasting effects that determine the average growth of real activity. This channel explains the super non-neutrality of money in a real business-cycle model.