Monetary Theory: The Basic New Keynesian Model
Behzad Diba
University of Bern
April 2011
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
1 / 12
Three Equations
The basic New Keynesian model with Calvo price setting simpli…es to
a system of three equations
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
2 / 12
Three Equations
The basic New Keynesian model with Calvo price setting simpli…es to
a system of three equations
1
The New Keynesian Phillips curve relating in‡ation to the output gap
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
2 / 12
Three Equations
The basic New Keynesian model with Calvo price setting simpli…es to
a system of three equations
1
2
The New Keynesian Phillips curve relating in‡ation to the output gap
A "Dynamic IS Equation" linking the evolution of aggregate demand
(and the output gap) to the nominal interest rate
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
2 / 12
Three Equations
The basic New Keynesian model with Calvo price setting simpli…es to
a system of three equations
1
2
3
The New Keynesian Phillips curve relating in‡ation to the output gap
A "Dynamic IS Equation" linking the evolution of aggregate demand
(and the output gap) to the nominal interest rate
A monetary-policy rule for setting the nominal interest rate (or, a
money-supply rule plus a money-demand speci…cation)
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
2 / 12
Three Equations
The basic New Keynesian model with Calvo price setting simpli…es to
a system of three equations
1
2
3
The New Keynesian Phillips curve relating in‡ation to the output gap
A "Dynamic IS Equation" linking the evolution of aggregate demand
(and the output gap) to the nominal interest rate
A monetary-policy rule for setting the nominal interest rate (or, a
money-supply rule plus a money-demand speci…cation)
These equations determine the real interest rate, in‡ation, and the
output gap
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
2 / 12
Three Equations
The basic New Keynesian model with Calvo price setting simpli…es to
a system of three equations
1
2
3
The New Keynesian Phillips curve relating in‡ation to the output gap
A "Dynamic IS Equation" linking the evolution of aggregate demand
(and the output gap) to the nominal interest rate
A monetary-policy rule for setting the nominal interest rate (or, a
money-supply rule plus a money-demand speci…cation)
These equations determine the real interest rate, in‡ation, and the
output gap
We will derive the …rst two equations and put them together with a
policy rule below
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
2 / 12
The Output Gap
De…ne the natural level of output as the level in the ‡exible-price
equilibrium, and let ytn denote the logarithm of natural output
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
3 / 12
The Output Gap
De…ne the natural level of output as the level in the ‡exible-price
equilibrium, and let ytn denote the logarithm of natural output
For example, in our model with iso-elastic utility and the production
function
yt = at + (1 α)nt ,
(1)
0 < α < 1, we got
ytn =
(1
α)[log(1 α) µ]
+
ϕ + α + σ ασ
ϕ+1
ϕ + α + σ ασ
at
(2)
relating ytn to productivity shocks
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
3 / 12
The Output Gap
De…ne the natural level of output as the level in the ‡exible-price
equilibrium, and let ytn denote the logarithm of natural output
For example, in our model with iso-elastic utility and the production
function
yt = at + (1 α)nt ,
(1)
0 < α < 1, we got
ytn =
(1
α)[log(1 α) µ]
+
ϕ + α + σ ασ
ϕ+1
ϕ + α + σ ασ
at
(2)
relating ytn to productivity shocks
We de…ne the output gap as
s
yt = yt
ytn ,
and de…ne recessions as periods with a negative output gap
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
3 / 12
The Output Gap
De…ne the natural level of output as the level in the ‡exible-price
equilibrium, and let ytn denote the logarithm of natural output
For example, in our model with iso-elastic utility and the production
function
yt = at + (1 α)nt ,
(1)
0 < α < 1, we got
ytn =
(1
α)[log(1 α) µ]
+
ϕ + α + σ ασ
ϕ+1
ϕ + α + σ ασ
at
(2)
relating ytn to productivity shocks
We de…ne the output gap as
s
yt = yt
ytn ,
and de…ne recessions as periods with a negative output gap
Comparison to real-world measures, and the role of productivity
shocks
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
3 / 12
Real Marginal Cost
Recall that with ‡exible prices real marginal cost is constant at the
steady-state value
e 1
mc = log
,
e
which is the inverse of the monopoly markup
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
4 / 12
Real Marginal Cost
Recall that with ‡exible prices real marginal cost is constant at the
steady-state value
e 1
mc = log
,
e
which is the inverse of the monopoly markup
Recall also that, with sticky prices, real marginal cost is positively
related to output because an increase in output increases the real
wage, and may also lead to diminishing marginal product of labor
(mpn in the textbook) if we have a …xed factor in the production
function
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
4 / 12
Real Marginal Cost
Recall that with ‡exible prices real marginal cost is constant at the
steady-state value
e 1
mc = log
,
e
which is the inverse of the monopoly markup
Recall also that, with sticky prices, real marginal cost is positively
related to output because an increase in output increases the real
wage, and may also lead to diminishing marginal product of labor
(mpn in the textbook) if we have a …xed factor in the production
function
For example, with our iso-elastic speci…cation, with (1), we get
mc
ct =
(Institute)
σ+
α+ϕ
1 α
s
yt
Monetary Theory: The Basic New Keynesian Model
April 2011
4 / 12
Marginal Cost and Output
mct = (wt pt) mpnt
= ( yt + ' nt) (yt
'+
yt
=
+
1
Under ‡exible prices
'+
mc =
+
ytn
1
=) ytn =
where
y
where yt
(
ytn
log(1 ))(1 )
+'+ (1 )
> 0 and
=) mc
ct =
yet is the output gap
nt) log(1
)
1+'
at log(1
1
1+'
at
1
y
+
ya
'+
+
1
ya at
1+'
+'+ (1
(yt
log(1
)
(6)
)
(7)
).
ytn)
(8)
Real Marginal Cost and the Output Gap
Note that this equation,
mc
ct =
σ+
α+ϕ
1 α
s
yt ,
relates the proportional deviation of real marginal cost from its
steady-state value to the output gap
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
5 / 12
Real Marginal Cost and the Output Gap
Note that this equation,
mc
ct =
σ+
α+ϕ
1 α
s
yt ,
relates the proportional deviation of real marginal cost from its
steady-state value to the output gap
1
with α = 0, the connection involves the preference parameters σ and
ϕ, re‡ecting the e¤ect of output on real wages
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
5 / 12
Real Marginal Cost and the Output Gap
Note that this equation,
mc
ct =
σ+
α+ϕ
1 α
s
yt ,
relates the proportional deviation of real marginal cost from its
steady-state value to the output gap
1
2
with α = 0, the connection involves the preference parameters σ and
ϕ, re‡ecting the e¤ect of output on real wages
with 0 < α < 1, we have the additional e¤ect of the diminishing
marginal product of labor
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
5 / 12
Real Marginal Cost and the Output Gap
Note that this equation,
mc
ct =
σ+
α+ϕ
1 α
s
yt ,
relates the proportional deviation of real marginal cost from its
steady-state value to the output gap
1
2
with α = 0, the connection involves the preference parameters σ and
ϕ, re‡ecting the e¤ect of output on real wages
with 0 < α < 1, we have the additional e¤ect of the diminishing
marginal product of labor
Either way, an expansion of output raises real marginal cost, and this
erodes the monopoly markup
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
5 / 12
Real Marginal Cost and the Output Gap
Note that this equation,
mc
ct =
σ+
α+ϕ
1 α
s
yt ,
relates the proportional deviation of real marginal cost from its
steady-state value to the output gap
1
2
with α = 0, the connection involves the preference parameters σ and
ϕ, re‡ecting the e¤ect of output on real wages
with 0 < α < 1, we have the additional e¤ect of the diminishing
marginal product of labor
Either way, an expansion of output raises real marginal cost, and this
erodes the monopoly markup
New prices, in Calvo’s model, rise with real marginal cost (in response
to the erosion of the markup), and this leads to in‡ation
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
5 / 12
The New Keynesian Phillips Curve (NKPC)
More precisely, we saw that (with Calvo price setting) in‡ation
dynamics are governed by
π t = βEt π t +1 + λmc
ct
with a coe¢ cient λ > 0 that is inversely related to the degree of price
rigidity θ
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
6 / 12
The New Keynesian Phillips Curve (NKPC)
More precisely, we saw that (with Calvo price setting) in‡ation
dynamics are governed by
π t = βEt π t +1 + λmc
ct
with a coe¢ cient λ > 0 that is inversely related to the degree of price
rigidity θ
Combining this with
mc
ct =
σ+
α+ϕ
1 α
s
yt
we get the New Keynesian Phillips Curve
s
π t = βEt π t +1 + κ yt
with
κ = λ σ+
(Institute)
α+ϕ
1 α
>0
Monetary Theory: The Basic New Keynesian Model
April 2011
6 / 12
Digression: Phillips Curves, Old and New
The original Phillips Curve
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Monetary Theory: The Basic New Keynesian Model
April 2011
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Digression: Phillips Curves, Old and New
The original Phillips Curve
1
inverse relation, in the data, between in‡ation and unemployment
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
7 / 12
Digression: Phillips Curves, Old and New
The original Phillips Curve
1
2
inverse relation, in the data, between in‡ation and unemployment
the traditional Keynesian interpretation
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
7 / 12
Digression: Phillips Curves, Old and New
The original Phillips Curve
1
2
3
inverse relation, in the data, between in‡ation and unemployment
the traditional Keynesian interpretation
an in‡ation-unemployment (in‡ation-output) trade-o¤ for
policymakers?
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
7 / 12
Digression: Phillips Curves, Old and New
The original Phillips Curve
1
2
3
inverse relation, in the data, between in‡ation and unemployment
the traditional Keynesian interpretation
an in‡ation-unemployment (in‡ation-output) trade-o¤ for
policymakers?
The Phelps-Friedman "Expectations-augmented" Phillips Curve
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
7 / 12
Digression: Phillips Curves, Old and New
The original Phillips Curve
1
2
3
inverse relation, in the data, between in‡ation and unemployment
the traditional Keynesian interpretation
an in‡ation-unemployment (in‡ation-output) trade-o¤ for
policymakers?
The Phelps-Friedman "Expectations-augmented" Phillips Curve
the New Classical rendition (with Rational Expectations)
π t = Et 1 π t + κ (yt
(Institute)
ytn ) , κ > 0
Monetary Theory: The Basic New Keynesian Model
April 2011
7 / 12
Digression: Phillips Curves, Old and New
The original Phillips Curve
1
2
3
inverse relation, in the data, between in‡ation and unemployment
the traditional Keynesian interpretation
an in‡ation-unemployment (in‡ation-output) trade-o¤ for
policymakers?
The Phelps-Friedman "Expectations-augmented" Phillips Curve
the New Classical rendition (with Rational Expectations)
π t = Et 1 π t + κ (yt
ytn ) , κ > 0
may arise from the Lucas aggregate-supply curve
yt = ytn + φ (pt
Et 1 pt ) , φ > 0
(setting κ = 1/φ)
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
7 / 12
Digression: Phillips Curves, Old and New
The original Phillips Curve
1
2
3
inverse relation, in the data, between in‡ation and unemployment
the traditional Keynesian interpretation
an in‡ation-unemployment (in‡ation-output) trade-o¤ for
policymakers?
The Phelps-Friedman "Expectations-augmented" Phillips Curve
the New Classical rendition (with Rational Expectations)
π t = Et 1 π t + κ (yt
ytn ) , κ > 0
may arise from the Lucas aggregate-supply curve
yt = ytn + φ (pt
Et 1 pt ) , φ > 0
(setting κ = 1/φ)
Contrast with the forward-looking NKPC
π t = βEt π t +1 + κ (yt
(Institute)
ytn ) , κ > 0
Monetary Theory: The Basic New Keynesian Model
April 2011
7 / 12
Dynamic IS Equation
The consumers’Euler equation governs the evolution of aggregate
demand, given our market-clearing condition Ct = Yt
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
8 / 12
Equilibrium
Goods markets clearing
Yt(i) = Ct(i)
for all i 2 [0; 1] and all t.
R1
1 1
Letting Yt
di
Y
(i)
0 t
1
,
Yt = Ct
for all t. Combined with the consumer’s Euler equation:
yt = Etfyt+1g
1
(it
Etf
t+1 g
)
(5)
Dynamic IS Equation
The consumers’Euler equation governs the evolution of aggregate
demand, given our market-clearing condition Ct = Yt
De…ne the natural real interest rate rtn as the real rate in the
‡exible-price equilibrium
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
8 / 12
Dynamic IS Equation
The consumers’Euler equation governs the evolution of aggregate
demand, given our market-clearing condition Ct = Yt
De…ne the natural real interest rate rtn as the real rate in the
‡exible-price equilibrium
Recall that rtn depends on productivity, but not on the prevailing
nominal interest rate (nor anything else that monetary policy can
a¤ect)
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
8 / 12
Dynamic IS Equation
The consumers’Euler equation governs the evolution of aggregate
demand, given our market-clearing condition Ct = Yt
De…ne the natural real interest rate rtn as the real rate in the
‡exible-price equilibrium
Recall that rtn depends on productivity, but not on the prevailing
nominal interest rate (nor anything else that monetary policy can
a¤ect)
For example, in our iso-elastic speci…cation leading to (2), we have
ytn =
and
rtn = ρ + σ
(Institute)
1 n
(r
σ t
ρ) + Et ytn+1
ϕ+1
ϕ + α + σ ασ
Et (∆at +1 )
Monetary Theory: The Basic New Keynesian Model
April 2011
8 / 12
IS Equation and the Output Gap
Combining the Euler equations in the two equilibria (with ‡exible and
sticky prices), we can relate the evolution of the output gap to the
interest-rate gap rt rtn
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
9 / 12
New Keynesian Phillips Curve
t
where
=
+ '+
.
1
Et f
t+1 g
+
yet
(9)
Dynamic IS equation
1
yet = Etfe
yt+1g
(it
Etf
t+1 g
rtn)
(10)
where rtn is the natural rate of interest, given by
rtn
=
Missing block:
+
+
n
Etf yt+1
g
ya Et f at+1 g
description of monetary policy (determination of it).
IS Equation and the Output Gap
Combining the Euler equations in the two equilibria (with ‡exible and
sticky prices), we can relate the evolution of the output gap to the
interest-rate gap rt rtn
Monetary policy a¤ects the output gap through its e¤ect on the
interest-rate gap:
yt
ytn = Et (yt +1
ytn+1 )
i.e.
s
s
yt = Et (yt +1 )
(Institute)
1
[it
σ
1
[rt
σ
Et ( π t + 1 )
rtn ] ,
rtn ]
Monetary Theory: The Basic New Keynesian Model
April 2011
9 / 12
Interest-rate Rules
We can close the model by specifying an interest-rate rule for
monetary policy
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
10 / 12
New Keynesian Phillips Curve
t
where
=
+ '+
.
1
Et f
t+1 g
+
yet
(9)
Dynamic IS equation
1
yet = Etfe
yt+1g
(it
Etf
t+1 g
rtn)
(10)
where rtn is the natural rate of interest, given by
rtn
=
Missing block:
+
+
n
Etf yt+1
g
ya Et f at+1 g
description of monetary policy (determination of it).
Interest-rate Rules
We can close the model by specifying an interest-rate rule for
monetary policy
For example, near the steady state with zero in‡ation, a Taylor Rule
s
it = ρ + φπ π t + φy yt + υt
delivers determinacy if it satis…es the Taylor Principle, φπ > 1, and
φy
0 (the necessary condition for determinacy, presented in the
textbook, is a bit weaker)
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
10 / 12
Equilibrium under a Simple Interest Rate Rule
it =
+
t
+
y
yet + vt
(11)
where vt is exogenous (possibly stochastic) with zero mean.
Equilibrium Dynamics:
yet
t
where
AT
and
1
+ y+
combining (9), (10), and (11)
= AT
Etfe
yt+1g
+ BT (b
rtn
Etf t+1g
1
+ ( +
y)
;
BT
vt )
(12)
1
Uniqueness () AT has both eigenvalues within the unit circle
Given
0 and
y
0, (Bullard and Mitra (2002)):
(
is necessary and su¢ cient.
1) + (1
)
y
>0
Interest-rate Rules
We can close the model by specifying an interest-rate rule for
monetary policy
For example, near the steady state with zero in‡ation, a Taylor Rule
s
it = ρ + φπ π t + φy yt + υt
delivers determinacy if it satis…es the Taylor Principle, φπ > 1, and
φy
0 (the necessary condition for determinacy, presented in the
textbook, is a bit weaker)
Here, υt represents a "monetary-policy shock" and may, for example,
follow an exogenous AR(1) process
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
10 / 12
Interest-rate Rules
We can close the model by specifying an interest-rate rule for
monetary policy
For example, near the steady state with zero in‡ation, a Taylor Rule
s
it = ρ + φπ π t + φy yt + υt
delivers determinacy if it satis…es the Taylor Principle, φπ > 1, and
φy
0 (the necessary condition for determinacy, presented in the
textbook, is a bit weaker)
Here, υt represents a "monetary-policy shock" and may, for example,
follow an exogenous AR(1) process
Although we can solve this simple model analytically, we usually rely
on a calibration and stochastic simulations to assess the quantitative
implications of our models
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
10 / 12
E¤ects of a Monetary Policy Shock
Set rbtn = 0 (no real shocks).
Let vt follow an AR(1) process
vt =
v
vt
1
+ "vt
Calibration:
v
= 0:5,
= 1:5,
y
= 0:5=4,
= 0:99,
= ' = 1,
= 2=3,
= 4.
Dynamic e¤ects of an exogenous increase in the nominal rate (Figure 1):
Exercise: analytical solution
Figure 3.1: Effects of a Monetary Policy Shock (Interest Rate Rule))
E¤ects of a Technology Shock
Set vt = 0 (no monetary shocks).
Technology process:
at =
a
1
+ "at:
ya (1
a)
at
Implied natural rate:
rbtn =
Dynamic e¤ects of a technology shock (
Exercise: AR(1) process for
at
a
at
= 0:9) (Figure 2)
Figure 3.2: Effects of a Technology Shock (Interest Rate Rule)
Money-supply Rule
Alternatively, we may specify a policy rule that sets the money
supply– e.g., an AR(1) process for money growth– and solve the
(simple) model or simulate (richer) models
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
11 / 12
Money-supply Rule
Alternatively, we may specify a policy rule that sets the money
supply– e.g., an AR(1) process for money growth– and solve the
(simple) model or simulate (richer) models
The practical motivation for this speci…cation is weaker because major
central banks use the nominal interest rate as their policy instrument
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
11 / 12
Equilibrium under an Exogenous Money Growth Process
mt =
m
mt
1
+ "m
t
(13)
Money market clearing
where lt
mt
b
bit
lt = ybt
= yet + ybtn
(14)
(15)
bit
pt denotes (log) real money balances.
Substituting (14) into (10):
(1 + ) yet =
Furthermore, we have
Etfe
yt+1g + b
lt +
b
lt
1
=b
lt +
t
Etf
mt
t+1 g
+
rbtn
ybtn
(16)
(17)
Equilibrium dynamics
3
2
3
2 n 3
2
Etfe
yt+1g
yet
rbt
AM;0 4 t 5 = AM;1 4 Etf t+1g 5 + BM 4 ybtn 5
b
b
mt
lt 1
lt 1
where
2
3
2
3
1+
0 0
1
1 0 5 ; AM;1 4 0
0 5 ; BM
AM;0 4
0
1 1
0 0 1
(18)
2
3
1 0
40 0 0 5
0 0
1
1
Uniqueness () AM
AM;0
AM;1 has two eigenvalues inside and one
outside the unit circle.
E¤ects of a Monetary Policy Shock
Set rbtn = ytn = 0 (no real shocks).
Money growth process
mt =
where
m
2 [0; 1)
Figure 3 (based on
m
mt
m
1
+ "m
t
= 0:5)
E¤ects of a Technology Shock
Set
mt = 0 (no monetary shocks).
Technology process:
at =
Figure 4 (based on
Empirical Evidence
a
= 0:9).
a
at
1
+ "at:
(19)
Figure 3.3: Effects of a Monetary Policy Shock (Money Growth Rule)
Figure 3.4: Effects of a Technology Shock (Money Growth Rule)
Money-supply Rule
Alternatively, we may specify a policy rule that sets the money
supply– e.g., an AR(1) process for money growth– and solve the
(simple) model or simulate (richer) models
The practical motivation for this speci…cation is weaker because major
central banks use the nominal interest rate as their policy instrument
But the ability of various models to generate liquidity e¤ects, under
money-supply rules, has motivated some academic researchers
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
11 / 12
New Keynesian (NK) Insights
The core RBC framework plays an important role in the NK model,
and in its implications for the e¤ects of productivity (and …scal)
shocks
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
12 / 12
New Keynesian (NK) Insights
The core RBC framework plays an important role in the NK model,
and in its implications for the e¤ects of productivity (and …scal)
shocks
The NK model’s household block (maximizing utility over time)
makes it very di¤erent from traditional Keynesian models
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
12 / 12
New Keynesian (NK) Insights
The core RBC framework plays an important role in the NK model,
and in its implications for the e¤ects of productivity (and …scal)
shocks
The NK model’s household block (maximizing utility over time)
makes it very di¤erent from traditional Keynesian models
The NK concept of stabilization policy is fundamentally di¤erent from
the traditional notion of stabilizing (de-trended) output
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
12 / 12
New Keynesian (NK) Insights
The core RBC framework plays an important role in the NK model,
and in its implications for the e¤ects of productivity (and …scal)
shocks
The NK model’s household block (maximizing utility over time)
makes it very di¤erent from traditional Keynesian models
The NK concept of stabilization policy is fundamentally di¤erent from
the traditional notion of stabilizing (de-trended) output
the output target ytn depends on productivity
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
12 / 12
New Keynesian (NK) Insights
The core RBC framework plays an important role in the NK model,
and in its implications for the e¤ects of productivity (and …scal)
shocks
The NK model’s household block (maximizing utility over time)
makes it very di¤erent from traditional Keynesian models
The NK concept of stabilization policy is fundamentally di¤erent from
the traditional notion of stabilizing (de-trended) output
the output target ytn depends on productivity
as an illustration, consider the e¤ects of a productivity shock in the
simple model with one-period price rigidity
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
12 / 12
New Keynesian (NK) Insights
The core RBC framework plays an important role in the NK model,
and in its implications for the e¤ects of productivity (and …scal)
shocks
The NK model’s household block (maximizing utility over time)
makes it very di¤erent from traditional Keynesian models
The NK concept of stabilization policy is fundamentally di¤erent from
the traditional notion of stabilizing (de-trended) output
the output target ytn depends on productivity
as an illustration, consider the e¤ects of a productivity shock in the
simple model with one-period price rigidity
The NK model o¤ers fundamentally new insights about the
output-in‡ation "trade-o¤" facing the central bank, as we will see in
Chapter 4
(Institute)
Monetary Theory: The Basic New Keynesian Model
April 2011
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