Discussion Paper Series 2004-E-10

Technology Shocks and the Role of Monetary Policy in the Beauty Contest Monetarist Model

Takuji Kawamoto

In this paper, we develop a quantitative, general-equilibrium business cycle model with imperfect common knowledge regarding technology shocks. We first show that the model has the ability to explain the short-run contractionary effects of technology improvements that are found by recent empirical studies such as GalĂ­ (1999) and Basu, Fernald, and Kimball (2002). In particular, the model predicts that a positive technology shock leads to a persistent decline in employment and a delayed, sluggish fall in inflation. Then we examine the role of monetary policy in stabilizing macroeconomic fluctuations originating from technology shocks. We show that monetary policy tends to fall short of accommodation of technology improvements when the central bank has only imperfect information on the state of the technology.

Keywords: Technology Shocks; Imperfect Common Knowledge; Employment; Inflation; and Monetary Policy

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2004 Bank of Japan All Rights Reserved.

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