Hello everyone,
I am having a hard time understanding households (or Govt.) budget constraints that include bonds in RBC models.
I first write the budget constraint in Nominal terms and when I divide it with current price level to get it in real terms inflation shows up (associated with the previous period’s stock of bond, just like in NK models). Should I just write the BC directly in real terms so there’s no inflation ? (which I’ve been hesitant to do as I think economic transactions happen in nominal terms)
bt/R + …= bt-1/Inflation + … , where bt is real Bond.
Does this hold in RBC models ? if not how do I get rid of inflation?
I’ve seen papers just ignore inflation as if price level was constant. What would be the rational behind constant prices and an inflation of 1 in RBC models? anything to do with marginal cost etc. ?
Thank you
Not sure there is a big intuition here. If price is important to you in the model…then put inflation in the model. If price is not important to the mechanism you are studying, you can normalize it to 1 or constant.
The standard RBC model features no nominal frictions. Thus, the real allocations that you usually care about are a function of the relative prices, not the money prices. The final good is typically chosen as the numeraire and all other prices like e.g. real wages are expressed in terms of the final good. You could of course add a layer of money to the model, which would result in the classical monetary economy (e.g. DSGE_mod/Gali_2015_chapter_2.mod at master · JohannesPfeifer/DSGE_mod · GitHub) In that model, the classical dichotomy holds. Money will only pin down inflation, but will not affect any real variables…
