I have a basic question about Interpretation of IRFs.
The paper which dynare file is going to replicate is Frank Schorfheide (2000): “Loss function-based evaluation of DSGE models”,Journal of Applied Econometrics, 15(6), 645-670. and the corresponding dynare file fs2000.mod tries to replicate the estimation of the cash in advance model.
There are two shocks in this system, TFP shock and money supply shock. Besides, this is a detrended model. Since we don’t detrend interest rate, it should be interpreted directly. But if we see the IRFs with respect to money supply shock, with a positive shock, the interest rate goes up…it doesn’t make sense… right? With more money supply in the system, equilibrium interest rate should go down instead of other way around…
What I am missing here? Could anyone help me here?? I appreciate it a lot!!
output rises after impact of the unanticipated money shock and then decays monotonically.
In the standard cash-in-advance model M1 households can adjust their deposits
contemporaneously in response to the money growth shock. The nominal interest rate is
approximately equal to the real interest rate plus expected inflation. The money growth shock
increases the expected inflation rate. Thus, the nominal interest rate rises and output slightly
decreases. The model does not generate a liquidity effect. Both DSGE models predict a sudden
increase in the price level which results in too much inflation in the first period.