Examining Business Cycles and Optimal Monetary Policy in a Regional DSGE Model

In this paper, I construct a dynamic stochastic general equilibrium (DSGE) model consisting of geographic regions and use state level data to estimate the effects that monetary policy and financial shocks have on the four census regions of the United States. The DSGE model I use is constructed around a centralized monetary authority and financial market with regional output, labor and investment markets and is a close variant of the FRBNY model (Del Negro et al. 2013). I use a combination of state level and national level data to estimate the regional and national parameters of the DSGE model. I find significant heterogeneity amongst the regional structural parameters of the model, creating different dynamics for the four regions in regard to national monetary and financial shocks. Simulating the estimated model, I find that monetary policy that considers the regional variation in output and inflation can significantly lower a central bank’s loss function while also being Pareto improving to all four regions. The paper’s results suggest that regional macroeconomic conditions should be considered in monetary policy decisions.