Cyclical fluctuations, Microeconomics

Cyclical Fluctuations:

Consider a situation where the value of money above trend indicates an unexpectedly high level of money in the recent past. The model predicts that this excess above trend would induce a higher level of output, work effort, and investment, all relative to trend. That is to say, money, employment, and investment would vary procyclically. These predictions correspond to the data. On the other hand, some predictions generated by the model fit the data less tightly. A monetary shock would, according to the theory, lead to an increase in the general price level and a fall in the expected interest rate. The evidence seems to not to support the proposition that the rise in the price level is procyclical and the expected real interest rate is countercyclical. Since the production function is assumed not to change, and the capital stock is given in the short run,  the increase in the employment of labour implies that the marginal and average products of labour fall. The theory predicts that labour productivity and the real wage rate would be low when the volume of output and labour input are high. That is to say,  labour productivity and the real wage rate vary counter-cyclically. This proposition, again, is not consistent with the data.  The conclusion is that there might be limitations to a model constructed to explain business fluctuations driven entirely by monetary surprises. Incorporating shifts in the production function and assigning monetary shocks a secondary role might be a superior strategy.          

Posted Date: 11/10/2012 6:59:21 AM | Location : United States

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