How Well Does a Monetary Dynamic Equilibrium Model Account for Chilean Data?

The aim of this paper is to know how well a money-in-the-utility function model with a Taylor rule is able to match Chilean data, specially some monetary stylized facts. A dynamic stochastic general equilibrium model is formulated, solved and calibrated to evaluate its abilities to replicate the main features of the Chilean economy in the 1986-2000 period. In particular, I focus the attention on a possible explanation to what is called in the literature the “price puzzle”, the co-movement between interest rate and inflation. The solution of the model is adequately achieved through a perturbation method (second-order approximation). A positive transitory policy interest rate shock causes: (1) a temporary (insignificant) diminishment in output, (2) a decrease in real money balances, and (3) a temporary increase in inflation rate. These findings are relatively consistent with those obtained from impulse-response functions estimated for Chile. Therefore, the theoretical model proposed is able to explain and reproduce the co-movement between interest rate and inflation. This is caused by a Fisher effect and strengthened by the presence of a Taylor rule that depends positively on inflation deviation.