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

Author(s)
Dou, Winston W.; Lo, Andrew W; Muley, Ameya; Uhlig, Harald
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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.
Date issued
2020-11
URI
https://hdl.handle.net/1721.1/130491
Department
Sloan School of Management; Massachusetts Institute of Technology. Department of Economics
Journal
Annual Review of Financial Economics
Publisher
Annual Reviews
Citation
Dou, Winston W. et al. "Macroeconomic Models for Monetary Policy: A Critical Review from a Finance Perspective." Annual Review of Financial Economics 12, 1 (November 2020): 95-140. © 2020 Annual Reviews
Version: Original manuscript
ISSN
1941-1367
1941-1375

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