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Annual Review of Financial Economics

Volume 12, 2020

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

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.

Keyword(s): dynamic stochastic general equilibrium models, JEL C51, JEL G12, JEL G29, macrofinancial models, macroprudential policy, monetary policy analysis, systemic risk
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2020-11-01
2024-04-23
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Macroeconomic Models for Monetary Policy: A Critical Review from a Finance Perspective
Annual Review of Financial Economics 12, 95 (2020); https://doi.org/10.1146/annurev-financial-012820-025928
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