Embodied Technology and
Money Shocks
Lumps, Bumps, and Humps
Money, Output, and Prices in the
long Run
The long run
correlation between
money growth and
inflation is nearly
one.



Lucas (1980)
Barro (1991)
Rolnick/Weber (1994)
Money, Output, and Prices in the
long Run
The long run
correlation between
money growth and
GDP growth is
nearly zero


Geweke (1986)
Poirier (1991)
Money and Output in the
Short Run
The contemporaneous correlation
between is positive.
Further, the dynamic correlations are
also positive for both leads and lags

Cooley/Cho (1993)
Money and Output in the
Short Run
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
-0.1
-0.2
-0.3
-0.4
MB
M1
M2
x(-5)
x(-3)
x(-1)
x(+1)
x(+3)
x(+5)
VAR Analysis
(Christiano,Eichenbaum,Evans - 1998 )
 yt 
 yt 1  u yt 
 x   A L  x   u 
 t
 t 1   xt 
‘Y’ is a measure of real economic activity
‘X’ is a measure of monetary policy
Impulse Responses: Humps
Impulse Responses: Humps
Impulse Responses: Humps
Modeling Money
Any model based on the quantity theory
with flexible prices can explain long run
correlations between
money/output/prices
MV = PY
Modeling Money
The positive contemporaneous
correlation are also easily reproducible
by introducing various market frictions
 Fixed nominal wage contracts
 Short run price frictions
 Financial market frictions
Explaining the Humps with
Lumps and Bumps
Existing frameworks have difficulty
explaining the dynamic effects of
money
Existing frameworks rely on a “generic”
treatment of capital equipment
K t 1  1   K t  I t
Explaining the Humps with
Lumps and Bumps
At the plant level, capital investment is very
“lumpy” – occurring is short bursts
Over a 15 year period, 25% of a plant’s
capital expenditure take place within one year
– 50% occurs within a contiguous 3 year
period (Doms/Dunne – 1993)
Further, with rapidly evolving technology,
compatibility issues arise between old and
new machines
Modeling “Vintage Capital”
New capital equipment embodies the latest
technology which makes new capital
incompatible with old capital
Therefore, capital must be indexed by age
Kt 

N
i 1
K it
I t  K1t
K i 1,t 1  K it
K N ,t 1  0
Solving the Model
The model can be solved using standard methods for
solving dynamic systems
 Linearize the system around the steady state
 Solve for the stable saddle path using linear difference
equation techniques
Adding the vintage structure, however, greatly
increases the complexity of the system
 A “standard” treatment would involve a system of 6
equations/unknowns (first order)
 A vintage model with 8 vintage of capital involves a
system of 49 equations (8th order)
Results
Capital is assumed to have a
lifetime of 8 periods (two
years)
An experiment is run in
which a monetary innovation
of one standard deviation is
introduced
The model can reproduce
the hump shaped pattern
found in the data. However,
the model tends to exhibit
excessive volatility.
References
Barro, Robert, “Economic Growth in a Cross-Section of Countries",
1991, QJE
Christiano, L., M. Eichenbaum, C. Evans (1998), “Monetary Policy
Shocks: What Have We Learned and to What End?”, Handbook of
Macroeconomics
Cho, J.O. & Cooley, T.F., 1991. "The Business Cycle with Nominal
Contracts," RCER Working Papers
Doms M. and Timothy Dunne (1993), "Capital Adjustment Patterns
in Manufacturing Plants; Lumps and Bumps"
Geweke, John (1986),"The Super neutrality of Money in the United
States: An Interpretation of the Evidence“, Econometrica
Lucas, Robert (1980), “Two Illustrations of the Quantity Theory of
Money”, American Economic Review, 70
McCandless, George and Warren Weber (1995), “Some Monetary
Facts”, Federal Reserve of Minneapolis Quarterly Review
Poirier, Dale (1991), “A Bayesian View of Nominal Money and Real
Output Through a New Classical Macroeconomic Window”, Journal of
Business & Economic Statistics