Money in a Real Business Cycle Model

This paper constructs a real business cycle model in which real money balances yield utility. I calibrate the model to fit the first moments of U.S. data and I simulate a set of impulse response functions that are generated by the model for GDP, the rate of interest, money growth, and real balances. These theoretical impulse responses are compared with actual impulse responses from U.S. data. The model does a reasonably good job of capturing the dynamic interactions of money and real variables in U.S. data. It differs from most existing approaches by choosing a parameterization of utility for which the model admits the existence of indeterminate equilibria. I argue that this fact is critical in explaining the monetary propagation mechanism.