Towards a Compact, Empirically Verified Rational Expectations Model for Monetary Policy Analysis

Working Paper 96-8
by Jeffrey C. Fuhrer
1996 Series

Revised article published in Carnegie-Rochester Conference Series on Public Policy 47 (December 1997): 197-230.

This paper extends the sticky-price models of Fuhrer and Moore (1995a,b) to include explicit, optimization-based consumption and investment decisions. The goal is to use the resulting model for monetary policy analysis; consequently, strong emphasis is placed on empirical validation of the model. I use a canonical formulation of the consumer's problem from Campbell and Mankiw (1989), and a time-to-build investment model with costs of adjustment. The restrictions imposed by these models, in conjunction with those imposed on prices and output by the Fuhrer-Moore contracting specification, imply dynamic behavior that is grossly inconsistent with the data.

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