Asset returns, wage rigidity and the business cycle : a dynamic stochastic general equilibrium approach

Abstract

This thesis extends the standard New Keynesian framework to incorporate asset pricing capabilities. An economic model which includes CRRA utility, nominal price rigidity, due to Calvo (1983), capital adjustment costs due to Jermann (1998) and monetary policy using a simple Taylor rule is calibrated to match the moments observed in US economy from 1955 to 2008. It also incorporates an equation for real wage rigidity that previously has not been used in such a framework. The thesis investigates the capability of the model to jointly replicate asset pricing and business cycle facts. It also investigates whether the model can provide a theoretical link between monetary policy and asset prices. Lastly, the thesis also studies whether the form of real wage rigidity used here could be useful for future work. I find that while the model is able to replicate business cycle moments for consumption, investment and output, it fails to match the moments for hours worked, wages, wage bill or labor share. The model also fails to capture important asset pricing moments. While the model dynamics and results fail to show that real wage rigidity can provide a direct theoretical link between monetary policy and asset prices, they do show that real wage rigidity is an important part of the model. Lastly, the results also show that the particular wage equation presented in this thesis may not be viable in the future because it does not break the link between wages and marginal product of labor.