PEDRO PABLO ALVAREZ LOIS
to be developed. A relevant aspect in this regard refers to asymmetries: depending
on the state of the economy, similar policy actions will generate quantitatively dif-
ferent effects on the economy. In this paper, I consider the hypothesis of capacity
utilization constraints in the real side of the economy and portfolio rigidities in
the financial sector as the basis for developing an analytical framework consistent
with the aforementioned features of the monetary transmission mechanism. Such
a framework consists of a dynamic stochastic general equilibrium model which dis-
plays the non-neutralities of money needed to perform policy analysis in the short
run, as well as the production inflexibilities that are able to generate the asymmetric
dynamics of key macroeconomic variables documented in empirical research.
1.1. Capacity Utilization and Monetary Policy Performance. In the liter-
ature, there are several explanations for the asymmetric response that monetary
policy generates on the main macroeconomic variables. One of these arguments is
known as the capacity constraint hypothesis.1 The idea is that some firms find it
difficult to increase their capacity to produce in the short run, giving rise to supply
shortages and production bottlenecks. This is going to have important implications
on one particular relation which is at the heart of the science of monetary policy,
the Phillips curve. In this regard, when the economy experiences strong aggregate
demand, the impact on inflation will be greater when more firms are restricted in
their ability to raise output in the short run. Consequently, the short-run aggregate
supply equation or Phillips curve will display a convex shape, which has relevant
consequences for the performance of a monetary policy aimed at controlling infla-
tion. Certainly, if the economy is initially weak, easing monetary conditions will
primarily affect output, but if the economy is initially strong, a monetary expansion
will mainly affect prices.
Recently, a great deal of research has been devoted to test empirically the asym-
metric effects of monetary policy from the existence of a convex Phillips curve. In
this vein, Cover (1992), Karras (1996) and Alvarez-Lois (2000) provide evidence of
asymmetries between positive and negative monetary shocks on output and prices.
Weise (1999) making use of an econometric methodology that allows to test for
the different types of asymmetries finds that monetary shocks have dramatically
different effects depending on the state of the economy. But prices and output are
not the only macroeconomic variables studied in this context, there is also evidence
of asymmetries in the behavior of nominal interest rates.2
Despite the empirical evidence and the strong theoretical arguments put for-
ward, there is certainly a lack of a general equilibrium approximation to the issue
of asymmetries within the monetary macroeconomic literature. This paper aims
at filling this gap, developing a quantitative model of the monetary transmission
mechanism and analyzing its implications for the conduct of monetary policy.
1.2. ModelingcapacityWithinaMonetaryDSGEFramework. Themodel
developed here has two basic ingredients: (i) it incorporates a real side with pro-
duction inflexibilities that result in variable rates of utilization across firms and (ii)
1Other arguments are based on “menu costs” and nominal wage rigidities. Dupasquier and
Ricketts (1997) briefly survey some of the different sources of asymmetries in this regard. An-
other strand in the literature emphasizes the role credit market imperfections in the monetary
transmission mechanism. See, for instance, Bernanke, Gertler and Gilchrist (1998).
2See, for instance, Enders and Granger (1998) for evidence in this regard.