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Working Paper 2007-005C

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"Money and the Natural Rate of Interest: Structural Estimates for the United States and the Euro Area"
by Javier Andrés, J. David López-Salido, and Edward Nelson

We examine the role of money in three environments: the New Keynesian model with separable utility and static money demand; a nonseparable utility variant with habit formation; and a version with adjustment costs for holding real balances. The last two variants imply forward-looking behavior of real money balances, with forecasts of future interest rates entering current portfolio decisions. We conduct a structural econometric analysis of the U.S. and euro area economies. FIML estimates confirm the forward-looking character of money demand. A consequence is that real money balances are valuable in anticipating future variations in the natural interest rate.

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Category > Monetary Policy/Macroeconomics
Author > Edward Nelson