Inflation and uncertainty in New Keynesian models: A note

Abstract

This note studies the inflation-uncertainty relationship in a New Keynesian framework with Rotemberg pricing. Inflation in these models can be expressed as the discounted sum of current and expected future real marginal costs. The main point of this note is to highlight that real marginal costs in general equilibrium tend to be a convex function of output. This, ceteris paribus, makes higher uncertainty about future output increase current inflation, which can quantitatively off-set the deflationary effect of uncertainty via the precautionary savings channel (Basu and Bundick, 2017). • Inflation in New Keynesian models is linked to expected future real marginal costs. • Real marginal costs in these models tend to be a convex function of output. • This convexity makes supply uncertainty (via Jensen’s inequality) inflationary.