The IUP Journal of Applied Economics
A Business-Cycle Model with a Modified Cash-in-Advance Feature and Government Sector: The Case of Bulgaria (1999-2018)

Article Details
Pub. Date : Oct, 2020
Product Name : The IUP Journal of Applied Economics
Product Type : Article
Product Code : IJAE31020
Author Name : Aleksandar Vasilev
Availability : YES
Subject/Domain : Economics
Download Format : PDF Format
No. of Pages : 15

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Abstract

We augment an otherwise standard business cycle model with a richer government sector, and add a modified Cash-in-Advance (CIA) considerations. In particular, the CIA constraint of Cole (2020) is extended to include private investment and government consumption, and allows a proportion of total expenditure to be done using credit. This specification is then calibrated to Bulgarian data after the introduction of the currency board (1999-2018), which gives a role to money in accentuating economic fluctuations. In particular, the modified CIA constraint produces a mechanism that allows the framework to reproduce better observed variability and correlations among model variables and those characterizing the labor market in particular.


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It is a well-known fact, e.g., Prescott (1986), that the perfectly-competitive (Walrasian) approach to modeling labor markets in Real Business Cycles (RBC-that is, without money in the setup-does not fit data well, and thus creates a "puzzle" for neoclassical economists. More specifically, in the standard RBC model, the fluctuations in employment are due to movements in labor supply. In other words, households increase hours in the face of a raise in the return on labor, the wage, driven by shocks to technology. Instead, if an RBC model is to fit data better along the labor market dimension, even for a small economy like Bulgaria, shocks that work on labor demand and shift it around would be much better candidates to explain the observed fluctuations in the wage rate, aggregate hours and employment.

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