Macroeconomic Models for Monetary Policy: A Critical Review from a Finance Perspective

174 Pages Posted: 17 Jan 2017  

Winston Wei Dou

The Wharton School, University of Pennsylvania

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Ameya Muley

MIT

Harald Uhlig

University of Chicago - Department of Economics

Date Written: January 14, 2017

Abstract

We provide a critical review of macroeconomic models used for monetary policy at central banks from a finance perspective. We review the history of monetary policy modeling, survey the core monetary models used by major central banks, and construct an illustrative model for those readers who are unfamiliar with the literature. Within this framework, we highlight several important limitations of current models and methods, including the fact that local-linearization approximations omit important nonlinear dynamics, yielding biased impulse-response analysis and parameter estimates. We also propose new features for the next generation of macrofinancial policy models, including: a substantial role for a financial sector, the government balance sheet and unconventional monetary policies; heterogeneity, reallocation, and redistribution effects; the macroeconomic impact of large nonlinear risk-premium dynamics; time-varying uncertainty; financial sector and systemic risks; imperfect product market and markups; and further advances in solution, estimation, and evaluation methods for dynamic quantitative structural models.

Keywords: Macrofinancial Models; Dynamic Stochastic General Equilibrium Models; Macroprudential Policy; Systemic Risk; Monetary Policy Analysis

JEL Classification: G12, G29, C51

Suggested Citation

Dou, Winston Wei and Lo, Andrew W. and Muley, Ameya and Uhlig, Harald, Macroeconomic Models for Monetary Policy: A Critical Review from a Finance Perspective (January 14, 2017). Available at SSRN: https://ssrn.com/abstract=2899842

Winston Wei Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

2318 Steinberg Hall - Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Stata Center
Cambridge, MA 02142
United States

Ameya Muley

MIT ( email )

Cambridge, MA
United States

Harald Uhlig

University of Chicago - Department of Economics ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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