This is a short book. It aims to get across the essential elements of dynamics
that are used in modern treatments of the subject. More significantly, it aims
to do this through the means of examples. Some of these examples are purely
algebraic. But many others consider economic models: both microeconomic
and macroeconomic. Macroeconomics is replete with dynamic models – some
simple and others quite complex. But this is not true of microeconomics.
The Santa Fe Institute (SFI) is interested in understanding evolving complex
social, biological, and physical adaptive systems in a most general sense
(see Cowan et al. 1994). Those of us at SFI interested in the evolution of
social behavior have tended to focus on either small-scale societies or on specific
aspects of more complex societies, such as the economy.
For the past fifteen years the New Keynesian model has
served as a frame of reference for analyses of fluctuations
and stabilization policies.1 That framework has allowed the
rigor and internal consistency of dynamic general equilibrium
models to be combined with typically Keynesian
assumptions, like monopolistic competition and nominal
rigidities, thus setting the stage for a meaningful, welfarebased
analysis of the effects of alternative monetary policy
What a difference a few years can make! The financial crisis that engulfed mature economies
in the late 2000s has prompted much soul searching. Economists are now trying hard to
incorporate financial factors into standard macroeconomic models. However, the prevailing,
in fact almost exclusive, strategy is a conservative one. It is to graft additional so-called
financial “frictions” on otherwise fully well behaved equilibrium macroeconomic models, built
on real-business-cycle foundations and augmented with nominal rigidities.
The paper proposes an empirical VAR for the UK open economy in order to measure the effects of monetary policy shocks from 1981 to 2003. The identification of the VAR structure is based on short-run restrictions that are consistent with the general implications of a New Keynesian model. The identification scheme used in the paper is successful in identifying monetary policy shocks and solving the puzzles and anomalies regarding the effects of monetary policy shocks.