A Capital Market in an Equilibrium Business Cycle Model

45 Pages Posted: 15 Feb 2001 Last revised: 24 Nov 2022

See all articles by Robert J. Barro

Robert J. Barro

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: March 1979

Abstract

Previous equilibrium "business cycle" models are extended by the incorporation of an economy-wide capital market. One aspect of this ex-tension is that the relative price that appears in commodity supply and demand functions becomes an anticipated real rate of return on earning assets, rather than a ratio of actual to expected prices. From the stand-point of expectation formation, the key aspect of the extended model is that observation of the economy-wide nominal interest rate conveys current global information to individuals. With respect to the effect of money supply shocks on output, the model yields results that are similar to those generated in simpler models. Anew result concerns the behavior of the anticipated real rate of return on earning assets. Because this variable is the pertinent relative price for commodity supply and demand decisions, it turns out to be unambiguous that positive money surprises raise the anticipated real rate of return. In fact, this response provides the essential channel in this equilibrium model by which a money shock can raise the supply of commodities and thereby increase output. However, it is possible through a sort of "liquidity" effect that positive money surprises can depress the economy-wide nominal interest rate.

Suggested Citation

Barro, Robert J., A Capital Market in an Equilibrium Business Cycle Model (March 1979). NBER Working Paper No. w0326, Available at SSRN: https://ssrn.com/abstract=260504

Robert J. Barro (Contact Author)

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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