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

Posted: 10 Dec 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

Massachusetts Institute of Technology (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: November 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 the 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.

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 (November 2020). Annual Review of Financial Economics, Vol. 12, pp. 95-140, 2020, Available at SSRN: https://ssrn.com/abstract=3744666 or http://dx.doi.org/10.1146/annurev-financial-012820-025928

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

Ameya Muley

Massachusetts Institute of Technology (MIT) ( email )

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Cambridge, MA 02139-4307
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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