Monetary aggregates and business cycle in the Argentine economy. A small open economy model with endogenous money multiplier and currency substitution

Abstract

The procyclical nature of monetary aggregates has been one of the main topics of debate in monetary economics. Most of literature adopts some strategy that involves nominal rigidities or market imperfections in order to explain the causal role that monetary factors play in determining real economic activity. In this thesis I provide a novel explanation to the positive relationship between monetary and real variables in a context of full flexible prices and competitive markets. By adding currency substitution into a standard small open economy RBC model with endogenous money multiplier, the model manages to replicate the positive relationship between monetary aggregates and output in the Argentine economy under different exchange rate regimes. The model also explains the switch in the correlation between the money multiplier and output when exchange rate regime changes. Under a fixed exchange rate regime, the reverse causality mechanism works, and the positive correlation between monetary aggregates and output is driven by the money multiplier. When exchange rate is full flexible, the money multiplier reacts negatively to the productivity shock, and the positive correlation is explained by the currency substitution effect.