The subject of our research is the behavior of the economy in response to monetary and technology shocks. To understand these issues we use a Dynamic Money-in-the-Utility-Function framework. We implement a non-separable property of the utility function that implies non-neutrality of real money balances. We construct a toy theoretic model with two representative agents who maximize their functions subject to constraints. We analytically solve the model using a method of log-linearization around the steady state and obtain the system of linear equations. We analyze the response of economic equilibrium with respect to implemented shocks using a method of undetermined coefficients and solve a system of linear difference expectation equations. In addition to analytical solution we also present Impulse Response Functions of the model.
We compute the impacts of monetary and technology shocks on the model and find that in case of a positive monetary shock expected inflation effect dominates the liquidity effect, while in case of a positive productivity shock income effect dominates substitution effect. The findings regarding the impact of a technology shock contradict the theory of real business cycles that predicts the domination of substitution effect over the income effec
