Scribd Logo
Upload

Welcome to Scribd!

  • 40 views

    New Keynesian Model - Week 6 Lecture

    Uploaded by

    Alex Lancashire
    This document provides an overview of the New Keynesian macroeconomic model. It discusses how this model modifies the standard Real Business Cycle model by introducing sticky prices, which allows monetary policy to have real effects by influencing aggregate demand. It then outlines some of the key assumptions of the New Keynesian model, including monopolistic competition and price stickiness. Finally, it examines how this framework can be used to analyze the effects of monetary and fiscal policy shocks, and the concepts of the output gap and natural rate of interest.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd

    New Keynesian Model - Week 6 Lecture

    Uploaded by

    Alex Lancashire
    40 views3 pages
    This document provides an overview of the New Keynesian macroeconomic model. It discusses how this model modifies the standard Real Business Cycle model by introducing sticky prices, which allows monetary policy to have real effects by influencing aggregate demand. It then outlines some of the key assumptions of the New Keynesian model, including monopolistic competition and price stickiness. Finally, it examines how this framework can be used to analyze the effects of monetary and fiscal policy shocks, and the concepts of the output gap and natural rate of interest.

    Copyright

    © © All Rights Reserved

    Available Formats

    DOCX, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    This document provides an overview of the New Keynesian macroeconomic model. It discusses how this model modifies the standard Real Business Cycle model by introducing sticky prices, which allows monetary policy to have real effects by influencing aggregate demand. It then outlines some of the key assumptions of the New Keynesian model, including monopolistic competition and price stickiness. Finally, it examines how this framework can be used to analyze the effects of monetary and fiscal policy shocks, and the concepts of the output gap and natural rate of interest.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    40 views3 pages

    New Keynesian Model - Week 6 Lecture

    Uploaded by

    Alex Lancashire
    This document provides an overview of the New Keynesian macroeconomic model. It discusses how this model modifies the standard Real Business Cycle model by introducing sticky prices, which allows monetary policy to have real effects by influencing aggregate demand. It then outlines some of the key assumptions of the New Keynesian model, including monopolistic competition and price stickiness. Finally, it examines how this framework can be used to analyze the effects of monetary and fiscal policy shocks, and the concepts of the output gap and natural rate of interest.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 3

    ECN202 Macroeconomics Week 6 Lecture

    New Keynesian model

    We are going to modify our benchmark intertemporal model to allow for sticky prices. This will imply
    that money is not neutral. As a result, monetary policy will have real effects. This will provide scope
    for fiscal and monetary policy to stabilise the economy

    Given that there is now scope for monetary policy to stabilise the economy, we shall analyse optimal
    monetary policy and its implications

    Sticky Price

    All models considered so far have assumed perfect competition in both goods and labour markets

    As a result, we had flexible prices and wages (all agents are price takers)

    New Keynesian models modify the RBC model in a crucial way: they assume that firms have some
    control over the prices of their own goods

    However, this modification would not make sense in a perfect competition environment.
    Consequently, we first need to assume monopolistic competition.

    Model Assumptions

    We have a large number of firms and they all have some control over the (relative) price of their
    own good (monopolistic competition)

    This means that given the demand for their product, they set the price as a mark-up over marginal
    cost

    Next, we assume that it is costly for firms to re-set prices ('sticky-price' assumption)

    Thus, if a shock affects the demand for their good after they have set their prices rms will satisfy that
    demand.

    We are going to assume that the monetary policy instrument is the (nominal) interest rate

    The Money Market

    In our models we have assumed that the money supply (currency) is set by the central bank as its
    monopoly supplier

    Demand is chosen (given interest rates and income) by households and firms (households for short)

    This means that the nominal interest rate and prices are endogenous given the exogenous quantities
    (Ms ).

    However, if the central bank sets the interest rate (a price), then it becomes exogenous while the
    quantity becomes endogenous.
    Modelling Monetary Policy

    Starting from equilibrium, if the central bank implements a contractionary monetary policy

    This means that it raises interest rates

    This is a movement along the output demand schedule

    As output supply is passive, output contracts while labour supply rises due to the increase in interest
    rates

    So wages fall as does employment. Money demand contracts: the central bank matches this in order
    to ensure its chosen interest rate target

    Effects of monetary policy in the NK model

    The effects of fiscal policy shocks

    Starting from equilibrium

    Y d shifts upwards

    Recall that interest rates are set by CB, so these do


    not change I As output increases (via demand) firms
    must supply this: labour demand increases, pushing
    wages and employment upwards. The (passive) output
    supply increases. As output increases, money demand
    rises.
    The output gap and the natural rate of interest

    Price rigidities mean that prices and quantities in the NK model differ from those that would prevail
    under flexible prices (the RBC equivalent)

    For example, current output Y ∗ may be high due to a monetary policy shock but had prices been
    flexible output would have been equal to Ym

    Williamson defines the output gap as Ym − Y ∗

    These gaps are inefficient and are what provides scope for beneficial macroeconomic policy We can
    think of optimal policy as policies that aim to minimise the output gap as well as to equate the actual
    and the natural rates of interest.

    Note that in the RBC model the output gap is always equal to zero since Ym = Y ∗ , which responds to
    real shocks.

    You might also like