Monetary Policy and Business Cycle Analysis in an Optimising Model with Expectations Lags

Monetary models of the business cycle often neglect the importance of investment and the capital stock in the monetary transmission mechanism. Most of the recent literature assumes either investment adjustment costs or ignores capital altogether. This paper re-takes the argument put forward by Kydland and Prescott (1982) and Christiano and Todd (1996), namely, that firms face a planning period before undertaking investment expenditures. The resulting model is able to replicate some of the most salient characteristics of the business cycle, including lags from monetary policy actions to output.