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

Annual Review of Financial Economics, Forthcoming

95 Pages Posted: 17 Jan 2017 Last revised: 4 Jun 2020

See all articles by Winston Wei Dou

Winston Wei Dou

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering

Ameya Muley

MIT

Harald Uhlig

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

Multiple version iconThere are 2 versions of this paper

Date Written: June 3rd, 2020

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 (June 3rd, 2020). Annual Review of Financial Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2899842 or http://dx.doi.org/10.2139/ssrn.2899842

Winston Wei Dou (Contact Author)

University of Pennsylvania - The Wharton School ( email )

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National Bureau of Economic Research (NBER) ( email )

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Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering ( email )

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E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
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HOME PAGE: http://web.mit.edu/alo/www

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

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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