Dynamic New Keynesian Research Articles

Under the same (Chole)sky: DNK models, timing restrictions and recursive identification of monetary policy shocks

Recent structural VAR studies of the monetary transmission mechanism have voiced concerns about the use of recursive identification schemes based on short-run exclusion restrictions. We trace out the effects on impulse propagation of informational constraints embodying classical Cholesky-timing restrictions in otherwise standard Dynamic New Keynesian (DNK) models. By reinforcing internal propagation mechanisms and enlarging a model's equilibrium state space, timing restrictions may produce a non-trivial moving average component of the equilibrium representation, making finite order VARs a poor approximation of true adjustment paths to monetary impulses, albeit correctly identified. They can even serve as an independent source of model-based nonfundamentalness, thereby hampering shock identification via VAR methods. This notwithstanding, restricted DNK models are shown to feature (i) invertible equilibrium representations for the observables and (ii) fast-converging VAR coefficient matrices under empirically tenable parameterizations. This alleviates concerns about identification and lag truncation bias: low-order Cholesky-VARs do well at uncovering the transmission of monetary impulses in a truly Cholesky world.

FISCAL MULTIPLIERS AT THE ZERO LOWER BOUND: THE ROLE OF GOVERNMENT SPENDING PERSISTENCE

In this paper, I examine the role of government spending persistence on fiscal multipliers at the zero lower bound (ZLB) in a more realistic environment while keeping the model simple enough to identify mechanisms driving the result. In particular, I build on a standard dynamic New Keynesian (DNK) model with an occasionally binding ZLB and Rotemberg pricing with rebates, where the probability of hitting the ZLB and the government purchase shock are in line with US data. Moreover, I compute the multiplier in a state that mimics the Great Recession. The main findings of the paper are as follows: (1) the multiplier is non-monotonic in the persistence of government spending while the economy is at the ZLB; (2) given the persistence estimated from US data, the multiplier is 1.25; and (3) in the framework with perfect foresight or with aggregate resource cost for adjusting prices, the multiplier is around 1 or less.

Consumption and production-based CO2 pricing policies: macroeconomic trade-offs and carbon leakage

This paper applies a DYNK (Dynamic New Keynesian) model to compare the traditional environmental tax reform for greenhouse gas (GHG) emissions with a taxation scheme that taxes GHG emissions embodied in consumption within the framework of a unilateral policy of the EU-27. The embodied emissions of different commodities are taxed independently of their origin. The GHG tax rates applied are identical and new revenues are in both cases recycled via lower social security contributions of employers. The results show the macroeconomic results, driven by the different impact of the taxation schemes on price competitiveness of EU-27 firms. These differences drive the leakage and show negative leakage in the case of taxing embodied GHG emissions. Both taxation schemes are also regressive for household incomes emphasizing the importance of the choice of revenue recycling. In terms of emission reduction, we find the taxation of emissions embodied in consumption less effective.

Home production, employment, and monetary policy

Abstract I extend the textbook Dynamic New Keynesian (DNK) model to include home production and labor supply decisions along both extensive and intensive margins. Home production introduces an asymmetrical effect of wage changes on the employment rate and average labor hours. As a result, the cyclicality of total labor hours becomes ambiguous. When the elasticity of substitution between home and market goods is above a threshold value of 2, the aggregate hours become procyclical. In contrast, total labor hours are always countercyclical in the textbook model. This discrepancy is important for monetary policy: if a central bank excludes household production from its analysis, it mismeasures the output gap. The resulting welfare loss equals 0.013% in terms of consumption equivalence.

Inflation and output in New Keynesian models with a transient interest rate peg

A familiar result in the canonical Dynamic New Keynesian (DNK) model is that policymakers constrained by the zero bound can improve outcomes by promising to keep rates low after the zero bound is not binding. We examine a general class of interest rate pegs in a variety of DNK models. Standard versions of the model produce counterintuitive reversals where the effect of the interest rate peg can switch from highly expansionary to highly contractionary for modest changes in the length of the interest rate peg. This unusual behavior does not arise in sticky information models of the Phillips curve.

Targeting Long Rates in a Model with Segmented Markets

This paper develops a model of segmented financial markets in which the net worth of financial institutions limits the degree of arbitrage across the term structure. The model is embedded into the canonical Dynamic New Keynesian (DNK) framework. We estimate the model using data on the term premium. Our principal results include the following. First, the estimated segmentation coefficient implies a nontrivial effect of central bank asset purchases on yields and real activity. Second, there are welfare gains to having the central bank respond to the term premium, e.g., including the term premium in the Taylor Rule. Third, a policy that directly targets the term premium sterilizes the real economy from shocks originating in the financial sector. A term-premium peg can have significant welfare effects. (JEL E12, E23, E31, E43, E44, E52, E58)

Targeting Long Rates in a Model with Segmented Markets

This paper develops a model of segmented financial markets in which the net worth of financial institutions limits the degree of arbitrage across the term structure. The model is embedded into the canonical Dynamic New Keynesian (DNK) framework. We estimate the model using data on the term premium. Our principal results include the following. First, the estimated segmentation coefficient implies a nontrivial effect of central bank asset purchases on yields and real activity.Second, there are welfare gains to having the central bank respond to the term premium, e.g., including the term premium in the Taylor rule. Third, a policy that directly targets the term premium sterilizes the real economy from shocks originating in the financial sector. A term premium peg can have significant welfare effects.

Inflation and Output in New Keynesian Models with a Transient Interest Rate Peg

Recent monetary policy experience suggests a simple diagnostic for models of monetary non-neutrality. Suppose the central bank pegs the nominal interest rate below steady state for a reasonably short period of time. Familiar intuition suggests that this should be modestly inflationary, and a reasonable model should deliver such a prediction. We pursue this simple diagnostic in several variants of the familiar Dynamic New Keynesian (DNK) model. Some variants of the model produce counterintuitive inflation reversals where the effect of the interest rate peg can switch from highly inflationary to highly deflationary for only modest changes in the length of the interest rate peg. Curiously, this unusual behavior does not arise in a sticky information model of the Phillips curve.

Performance Pay and Shifts in Macroeconomic Correlations

A coincidence in time between the volatility break associated with the Great Moderation and large changes in the pattern of conditional and unconditional correlations between output, hours and labor productivity was detected by Gali?½ and Gambetti (2009). We provide a novel explanation for these findings, based on the major changes that occurred in the U.S. design of labor compensation around the mid-1980s. These include a substantial increase in the incidence of performance pay coupled with a higher responsiveness of real wages to the business cycle. We capture this shift in the structure of labor compensation in a Dynamic New Keynesian (DNK) model and show that, by itself, it generates the disappearance of the procyclical response of labor productivity to non-technology shocks and a reduction of the contractionary effects of technology shocks on hours worked. Moreover, it accounts for a large share of the observed drop in output volatility after 1984 and for most of the observed changes in unconditional correlations.

Monetary policy shocks, Choleski identification, and DNK models

A popular identifying assumption in structural VAR studies is that the monetary policy shock does not affect macroeconomic variables contemporaneously. We examine the consequences of using this identification strategy when the data-generating process is a basic Dynamic New Keynesian (DNK) model but without these assumed time delays. The principle conclusion is that the standard Choleski assumption can severely distort the impulse response functions, producing price puzzles and muted responses of inflation and the output gap to monetary shocks.

Inflation Persistence, Monetary Policy, and the Great Moderation

There is growing evidence that the empirical Phillips curve within the United States has changed significantly since the early 1980s. In particular, inflation persistence has declined sharply. This paper demonstrates that this decline is consistent with a standard dynamic New Keynesian (DNK) model in which: (i) the variability of technology shocks has declined and (ii) the central bank more aggressively responds to inflation.

Performance Pay and Shifts in Macroeconomic Correlations

A coincidence in time between the volatility break associated with the Great Moderation and large changes in the pattern of conditional and unconditional correlations among output, hours and labor productivity has been detected by Gali and Gambetti (2009). We provide a novel explanation for these findings, based on major changes occurred in the U.S. design of labor compensation around the mid-1980s. These include a substantial increase in the incidence of performance pay coupled with a higher responsiveness of real wages to the business cycle. We capture this shift in the structure of labor compensation in a Dynamic New Keynesian (DNK) model and show that, on its own, it generates the disappearance of the procyclical response of labor productivity to non-technology shocks and a reduction of the contractionary effects on hours worked of technology shocks. Moreover, it accounts for a large fraction of the observed drop in output volatility after 1984 and for most of the observed changes in unconditional correlations.

Inflation Persistence, Inflation Targeting, and the Great Moderation

There is growing evidence that the empirical Phillips curve within the US has changed significantly since the early 1980's. In particular, inflation persistence has declined sharply. The paper demonstrates that this decline is consistent with a standard Dynamic New Keynesian (DNK) model in which: (i) the variability of technology shocks has declined, and (ii) the central bank more aggressively responds to inflation.

New perspectives on capital, sticky prices, and the Taylor principle

Our main result is that dynamic new-Keynesian (DNK) models with firm-specific capital feature a substantial amount of endogenous price stickiness. We use this insight to assess the desirability of alternative interest rate rules, and make the case for combining active monetary policy with interest rate smoothing and/or some responsiveness of the nominal interest rate to real economic activity. The key mechanism behind our results is also useful from a positive point of view: the feature of firm-specific capital increases the empirical appealingness of DNK models, as documented by a growing body of literature.

Monetary models and technology shocks

Adding variable capital utilisation to a dynamic new Keynesian (DNK) framework gives a model which can produce realistic responses to both technology and monetary shocks. This requires the assumption of a much lower level of nominal rigidity than is usual.