Abstract
Abstract Recently developed HANK models, which combine Heterogeneous Agents and New Keynesian frictions, have had a considerable impact on macroeconomics. However, due to the complexity of such models, the literature has focused on numerically solved models and therefore little is known about their general properties. This paper presents a tractable HANK model that integrates Search and Matching (SAM) frictions in the labor market. The model features an endogenous idiosyncratic earnings risk, which may be procyclical or countercyclical. When this risk is countercyclical, which we argue is the empirically plausible case, there is a downward pressure on real interest rates in recessions due to a precautionary savings motive. We show that in this setting (a) the economy may get stuck in a high-unemployment steady state, (b) the Taylor principle is insufficient to eliminate the local indeterminacy of the intended steady state, and (c) nominal rigidities and inincomplete markets are complementary in terms of amplifying the impact of shocks on the macroeconomy.
Highlights
The New Keynesian (NK) model has gained widespread use both in academic research and in policy circles
We demonstrate how the incomplete markets wedge, in a model with search and matching frictions, is pinned down as a function of tightness of the labor market, how it interacts with the sticky-price wedge, and how it is a¤ected by policy
The essence of the interaction is that incomplete markets produces movements in aggregate demand in response to ‡uctuations in the job ...nding rate which impact on the supply side when there are nominal rigidities and creates a feedback mechanism
Summary
The New Keynesian (NK) model has gained widespread use both in academic research and in policy circles. We present an analytical formula for the local response to a productivity shock around the intended steady state and show that the presence of incomplete markets can create signi...cant ampli...cation, see Ravn and Sterk (2012) for numerical results. Speci...cally, we show that the precautionary savings mechanism in our model can overturn the paradox that, at the ZLB, positive productivity shocks may be contractionary, as well as the paradox that greater price ‡exibility may lead to larger drops in output Both paradoxes arise from the fact that, at the ZLB, a transitory decline in in‡ation increases the real interest rate temporarily. Speci...cally, our model predicts that the real interest rate declines during times when the labor market becomes less tight, which increases unemployment risk and strengthens the precautionary savings motive. We show how the observed variances of the real interest rate and the vacancy-unemployment ratio can be used to discipline the values of the model parameters controlling the strength of the precautionary savings e¤ects
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
