Analyzing the Monetary Model`s Response to Financial and Productivity Shocks

In this study, I analyze the shock responses of macro variables in a shopping-time monetary model, namely, the cash in advance (CIA) model, when the shock processes are calibrated by Bayesian regression. Two external disturbances related to financial variables-that is, productivity and monetary shocks-are introduced in the model. These shocks are then calibrated by a Markov Chain Monte Carlo (MCMC) method to fit the shock evolutionary process of the US economy during the period from 1947 through 2012. This calibration strategy outperforms the traditional calibration style in (i) matching the variables` correlation with the observed pattern in the analysis of the amplification and (ii) demonstrating persistence of the variables` impulse response to the shocks. The results also show the dominant substitution effect, consistently suggesting that a household elastically substitutes labor supply with leisure when an economy experiences a positive shock.