New Keynesian Model Research Articles

Estimation and Inference of Impulse Responses by Local Projections

This paper introduces methods to compute impulse responses without specification and estimation of the underlying multivariate dynamic system. The central idea consists in estimating local projections at each period of interest rather than extrapolating into increasingly distant horizons from a given model, as it is done with vector autoregressions (VAR). The advantages of local projections are numerous: (1) they can be estimated by simple regression techniques with standard regression packages; (2) they are more robust to misspecification; (3) joint or point-wise analytic inference is simple; and (4) they easily accommodate experimentation with highly nonlinear and flexible specifications that may be impractical in a multivariate context. Therefore, these methods are a natural alternative to estimating impulse responses from VARs. Monte Carlo evidence and an application to a simple, closed-economy, new-Keynesian model clarify these numerous advantages.

Factor Analysis in a New-Keynesian Model

New-Keynesian models are characterized by the presence of expectations as explanatory variables. To use these models for policy evaluation, the econometrician must estimate the parameters of expectation terms. Standard estimation methods have several drawbacks, including possible lack of identification of the parameters, misspecification of the model due to omitted variables or parameter instability, and the common use of inefficient estimation methods. Several authors have raised concerns over the validity of commonly used instruments to achieve identification. In this paper we analyze the practical relevance of these problems and we propose remedies to weak identification based on recent developments in factor analysis for information extraction from large data sets. Using these techniques, we evaluate the robustness of recent findings on the importance of forward looking components in the equations of the New-Keynesian model.

Optimal Discretionary Policy and Uncertainty About Inflation Persistence

This paper studies optimal discretionary policy with parameter uncertainty about inflation inertia. Optimal policy rules and impulse responses are presented within a hybrid New-Keynesian model estimated for the euro area by Smets (2003). We find that it may be optimal for policy to respond more aggressively to cost-push shocks and real interest rate shocks in the presence of uncertainty about inflation inertia, depending on the form of the central bank's objective function. Moreover, in the cases where optimal policy is not certainty equivalent, we find that inflation returns slightly more gradually to equilibrium following a shock when the degree of inflation inertia is uncertain.

Comments on “Fiscal and monetary policy interactions: Empirical evidence on optimal policy using a structural new-Keynesian model”

1. The objectiveThe objective of this paper is the empirical assessment of strategic complementar-ity or substitutability of fiscal and monetary policy.I believe that the most relevant issue on the interaction between monetary and fis-cal policies is the amount of coordination among the authorities necessary for eachauthority to reach its own goals. In a recent paper Sims (2003) has stressed that aprerequisite for central bank to control inflation is appropriate coordination withor backup by fiscal policy and that the nature of the required coordination dependson whether and how central bank independence from fiscal authorities has beenimplemented. The importance of the coordination between monetary and fiscalauthorities to achieve inflation stabilization has been originally strongly emphasizedin by Sargent and Wallace (1981) who illustrated how an undisciplined fiscal policymay exert pressures on the monetary authority to sooner or later monetize the def-icit. A different stream of the literature, usually categorized as the fiscal theory of theprice level (FTPL), puts at the center stage the role of the (monetary and fiscal) QTRpolicy mix in determining the joint dynamics of inflation and output. According tothis view, the strong anti-inflationary policy pursued in the US with the onset ofthe Volcker–Greenspan regime would not have sufficed to successfully moderateinflation without the fiscal adjustment that characterized the US economic policythroughout the nineties. While the argument pursued in several contributions of

Fiscal and monetary policy interactions: Empirical evidence and optimal policy using a structural New-Keynesian model

This paper examines the interaction of monetary and fiscal policies using an estimated New-Keynesian dynamic general equilibrium model for the US. In contrast to earlier work using VAR models, we show that the strategic complementarity or substitutability of fiscal and monetary policy depends crucially on the types of shocks hitting the economy, and on the assumptions made about the underlying structural model. We also demonstrate that countercyclical fiscal policy can be welfare-reducing if fiscal and monetary policy rules are inertial and not co-ordinated.

On the Indeterminacy of New-Keynesian Economics

We study identiÞcation in a class of three-equation monetary models. We argue that these models are typically not identiÞed. For any given exactly identiÞed model, we provide an algorithm that generates a class of equivalent models that have the same reduced form. We use our algorithm to provide four examples of the consequences of lack of identiÞcation. In our Þrst two examples we show that it is not possible to tell whether the policy rule or the Phillips curve is forward or backward looking. In example 3 we establish an equivalence between a class of models proposed by Benhabib and Farmer [1] and the standard new-Keynesian model. This result is disturbing since equilibria in the Benhabib-Farmer model are typically indeterminate for a class of policy rules that generate determinate outcomes in the new-Keynesian model. In example 4, we show that there is an equivalence between determinate and indeterminate models even if one knows the structural equations of the model. JEL Classification: C39, C62, D51, E52, E58

Optimal Monetary Policy Under Discretion with a Zero Bound on Nominal Interest Rates

We determine optimal discretionary monetary policy in a New-Keynesian model when nominal interest rates are bounded below by zero. Nominal interest rates should be lowered faster in response to adverse shocks than in the case without bound. Such preemptive is optimal because expectations of a possibly binding bound in the future amplify the effects of adverse shocks. Calibrating the model to the U.S. economy we find the easing effect to be quantitatively important. Moreover, significant welfare losses. Losses increase further when inflation is partly determined by lagged inflation in the Phillips curve. Targeting positive inflation rates reduces the frequency of a binding lower bound, but tends to reduce welfare compared to a target rate of zero. The welfare gains from policy commitment, however, appear significant and are much larger than in the case without lower bound.

Money in a New-Keynesian Model Estimated with German Data

In this paper we estimate a simple New-Keynesian DSGE model with German data for the sample period 1970:q1 to 1998:q4. Contrary to a number of recent similar papers estimated with US and euro-area data, we find that real money balances contribute significantly to the determination of inflation and of the dynamics of output. We estimate our model using a maximum likelihood technique under a full set of structural shocks. We do not rule out indeterminate solutions a priori. Under multiple stable paths we close the model using the minimum-state-variable solution.

Looking for the microfoundations : nominal rigidities and the New Keynesian economics

This paper presents a critical description of the most influential New-Keynesian models with nominal rigidities. The study aims to elucidate the concept of long-term contracts, small menu costs, and near-rationality. Since this approach avoids the formulation of market clearing price, the early New-Keynesian models are incomparable to those developed by New Classical Economy. Hence, the New Keynesian economics, contrary to the common interpretation, is unable to challenge its adversaries. (original abstract)

European Integration and Employment: A New Role for Active Fiscal Policies?

This paper theoretically investigates the impact of European integration on employment by developing a new-keynesian model where fiscal policy effectively reduces firms’ market power. Stronger product market competition is shown to reduce the marginal ability of governments to improve employment through public consumption. As competition crowds out fiscal spending, the positive impact of markets integration on employment is weakened. Moreover, in a context where national goods’ demand becomes “global”, the marginal benefit for each national fiscal authority of increasing public consumption is lower than the marginal benefit for the community. This result stresses one source of coordination failure within the EMU.

Keynes und seine Interpreten

Keynes started to develop a new economic paradigm that is different form the classical and neoclassical school. He stressed the role of effective demand, money, uncertainty and subjective expectations. Only the postkeynesian interpretation of Keynes follows the original ideas of Keynes. The IS-LM-model together with the neoclassical syntheses, the neokeynesian and the newkeynesian models reduce Keynes to short-run disturbances of the long-run neoclassical equilibrium.

Assessing Simple Policy Rules: A View from a Complete Macroeconomic Model

Monetary policy analysts looking for a model on which to base decisions may consider two popular approaches-the New Keynesian (NK) and the identified vector autoregression (VAR) approaches. Choosing between the two can be difficult: NK models are stylized and have simple rules while structural VAR models have complex dynamics and loose behavioral interpretations. ; The simpler NK models often produce stark conclusions. For example, NK analyses consistently find that the Federal Reserve's monetary policy has improved markedly in the past two decades compared with the 1960s and 1970s. In contrast, VARs find little instability in the policy parameters or in the dynamic impacts of exogenous shifts in policy. ; Taking the view that NK models are simply restricted VARs, the authors estimate systems of structural equations implied by NK models. They find that these estimated equations vary considerably over different periods. The authors also investigate the role of money by incorporating money (M2) into the NK model; they find that including money substantially alters the model's conclusions about monetary policy. This result conflicts with the NK theoretical assumption that money is irrelevant. ; Both NK models and VARs have their place in policy advising, the authors believe. But they caution that it is treacherous to draw inferences about policy effects solely from policy rules estimated in isolation from a complete macro model. (This abstract was borrowed from another version of this item.)

New Tests of the New-Keynesian Phillips Curve

Is the observed correlation between current and lagged inflation a function of backward-looking inflation expectations, or do the lags in inflation regressions merely proxy for rational forward-looking expectations, as in the new-Keynesian Phillips curve? Recent research has attempted to answer this question by using instrumental variables techniques to estimate "hybrid" specifications for inflation that allow for effects of lagged and future inflation. We show that these tests of forward-looking behavior have very low power against alternative, but non-nested, backward-looking specifications, and demonstrate that results previously interpreted as evidence for the new-Keynesian model are also consistent with a backward-looking Phillips curve. We develop alternative, more powerful tests, which find a very limited role for forward-looking expectations.

Monetary Policy under Neoclassical and New-Keynesian Phillips Curves, with an Application to Price Level and Inflation Targeting

This paper compares discretionary monetary policy under two Phillips curves. Previous work uses a Phillips curve consistent with \Neoclassical models of price adjustment. Sticky price models imply a \New-Keynesian Phillips curve based on staggered price setting that delivers familiar results on an inflationary bias and inflation contracts. However, the comparison of price level and inflation targeting reveals an output/price stability tradeoff under the New-Keynesian model that does not arise under the Neoclassical specification, illustrating the usefulness of considering the New-Keynesian model. Given the empirical support for the New-Keynesian specification, a stability tradeoff likely exists.

Responding to Large and Small Shocks When Business Cycles are Non-Linear

The possible presence of non-linear dynamics in macro-systems has become a preoccupation of much recent research in macroeconomics. In this paper we explore some of the empirical issues in the context of a New-Keynesian model with rational expectations in asset markets and nominal inertia in pricing and Wdges. We inject non-linearities into the pricing and investment decisions of firms and explore how this affects the way in which the economy responds to supply and demand shocks of varying magnitude. We find that when the shocks are mild the response to negative and positive shocks is more or less linear. However, when the shocks are large, major asymmetries are triggered. There are significant differences in the response of the economy to shocks of different signs and different sizes. Since the non-linearities we identify in pricing and investment are empirically founded, our results have a number of implications for the conduct of economic policy.

Monetary Policy under Neoclassical and New-Keynesian Phillips Curves, with an Application to Price Level and Inflation Targeting

This paper compares discretionary monetary policy under two Phillips curves. Previous work uses a Phillips curve consistent with "Neoclassical" models of price adjustment. Sticky price models imply a "New-Keynesian" Phillips curve based on staggered price setting that delivers familiar results on an inflationary bias and inflation contracts. However, the comparison of price level and inflation targeting reveals an output/price stability tradeoff under the New-Keynesian model that does not arise under the Neoclassical specification, illustrating the usefulness of considering the New-Keynesian model. Given the empirical support for the New-Keynesian specification, a stability tradeoff likely exists.

Business Cycles: The Nature and Causes of Economic Fluctuations

Preface Introduction Economic Behavior Over the Cycle Early Theories of the Cycle The Monetarist Model The Rational Expectations Model The New-Keynesian Model Real Business Cycles Important Features of Modern Models Historical Episodes Before World War II World War II to 1989 Some Macroeconomic Puzzles Economic Forecasting Bibliography Index

Flaw detector

Introducing bank reserves (or money) into the basic New Keynesian (NK) model offers a resolution of NK puzzles and paradoxes. The resulting models deliver local-equilibrium determinacy under an exogenous interest rate on reserves and an exogenous nominal stock of reserves, even for an arbitrarily small monetary friction. This leads to a resolution of the forward-guidance puzzle, the fiscal-multiplier puzzle, and the paradox of flexibility. As the monetary friction becomes vanishingly small, the models converge to the basic NK model and serve to select a particular equilibrium of that model - which also offers a resolution of the paradox of toil.