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Macroeconomic Modeling for Monetary Policy Evaluation
There were many debates and publications over the lack of efficient quantitative macroeconomic modeling in a period from 1970 to 1990. Famous economists Jordi Gali and Mark Gehtler in their papers try to analyze the reasons relating to the failure of current macroeconomic models of monetary policy and progress the framework for new models. The main indicator of unsuccessful modeling during those years was hesitant projections of the future economy made by lots of central banks. These forecasts were mainly based on traditional and insufficient macroeconomic models.(see Gali/Gehtler(2007)pp.25-45)
According to Gali and Gehtler, one of the main justification of unproductive models was the rigid critiques that addressed to these models by several macroeconomists. Due to having coefficients that are not durable for fluctuations on policy systems and structural alterations, current models were not at their optimum level to handle various difficulties (Sargent(1981) as cited by Gali/Gehtler(2007)). Thus, upcoming kinds of literature such as the New Keynesian model and the real business cycle were thought to be the core part of improvement for these macroeconomic models. Gali claims that, despite the Keynesian model, the real business cycle model is more suitable for a dynamic economy because of its consideration in quantitative ways rather than quality manners.
Gali and Gehtler provided key assumptions for frameworks work efficiently. They think that taking money as a single component must be differentiated with monetary policy. A general way that central banks try to apply for adapting wished real interest rates is regulating the money supply. However, it does not have any direct effect on aggregate demand. It is not deniable that the effectiveness of monetary policy highly connected to private sectors. This means that being attentive to the future expectations of individual households and firms while implementing policy attempts, brings effectiveness with itself. ‘If we can examine the aftermath of such periods, it is thought, we will see the effects of policy unclouded by the effects of other disturbances that might also shift policy'( Sims (1992),pp.978). Gali and Gehtler point out the baseline model that suits the new frameworks. They claim that to make price stability in the economy, firms must be forced to set prices unintentionally. This can be possible only if they face reduces on demand because of monopolistic competition made by policy instruments. In that way, it is possible to influence aggregate demand and aggregate supply which are highly correlated to the chain of monetary policy. Then Gali and Gehtler showed the ways how the model can be used in real-time monetary policy actions by taking into consideration two major features. Premier is the good administration of expectations and proper observing the changes in the economy’s natural equilibrium levels.
They mention that their baseline model is mainly for pedagogical purposes and can somehow not be suitable for implementing it to data. However, recent researches which are targeted to make this model practical work more than enough. In the end, Gali and Gehtler believe that their model shows huge progress despite its remained uncertainty for upcoming challenges in the economy.
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