scholarly journals Monetary Policy, Bounded Rationality, and Incomplete Markets

2019 ◽  
Vol 109 (11) ◽  
pp. 3887-3928 ◽  
Author(s):  
Emmanuel Farhi ◽  
Iván Werning
Keyword(s):  
Monetary Policy ◽  
Bounded Rationality ◽  
Incomplete Markets ◽  
Idiosyncratic Risk ◽  
Borrowing Constraints ◽  
New Keynesian ◽  
New Keynesian Model ◽  
Benchmark Model ◽  
Forward Guidance ◽  
Keynesian Model

This paper extends the benchmark New-Keynesian model by introducing two frictions: (i) agent heterogeneity with incomplete markets, uninsurable idiosyncratic risk, and occasionally-binding borrowing constraints; and (ii) bounded rationality in the form of level-k thinking. Compared to the benchmark model, we show that the interaction of these two frictions leads to a powerful mitigation of the effects of monetary policy, which is more pronounced at long horizons, and offers a potential rationalization of the “forward guidance puzzle.” Each of these frictions, in isolation, would lead to no or much smaller departures from the benchmark model. (JEL D52, D81, E12, E52)

scholarly journals Understanding HANK: Insights From a PRANK

Econometrica ◽  
2020 ◽  
Vol 88 (3) ◽  
pp. 1113-1158 ◽  
Author(s):  
Sushant Acharya ◽  
Keshav Dogra
Keyword(s):  
Monetary Policy ◽  
Fiscal Policy ◽  
Incomplete Markets ◽  
New Keynesian ◽  
New Keynesian Model ◽  
Income Risk ◽  
Heterogeneous Agent ◽  
Liquidity Trap ◽  
Forward Guidance ◽  
Keynesian Model

Using an analytically tractable heterogeneous agent New Keynesian model, we show that whether incomplete markets resolve New Keynesian “paradoxes” depends on the cyclicality of income risk. Incomplete markets reduce the effectiveness of forward guidance and multipliers in a liquidity trap only with procyclical risk. Countercyclical risk amplifies these “puzzles.” Procyclical risk permits determinacy under a peg; countercyclical risk may generate indeterminacy even under the Taylor principle. By affecting the cyclicality of risk, even “passive” fiscal policy influences the effects of monetary policy.

ARE MAJOR CENTRAL BANKS BLINDED BY THE ANALYTICAL ELEGANCE OF THEIR MODELS? POSSIBLE COSTS OF UNCONVENTIONAL MONETARY POLICY MEASURES

2017 ◽  
Vol 62 (01) ◽  
pp. 87-108 ◽  
Author(s):  
PIOTR CIŻKOWICZ ◽  
ANDRZEJ RZOŃCAZ
Keyword(s):  
Monetary Policy ◽  
Global Financial Crisis ◽  
Significant Risk ◽  
Central Banks ◽  
New Keynesian ◽  
New Keynesian Model ◽  
Unconventional Monetary Policy ◽  
Keynesian Model ◽  
Policy Measures ◽  
The Global Financial Crisis

We survey the possible costs of the unconventional monetary policy measures undertaken by major central banks after the outbreak of the global financial crisis in 2008. We argue that these costs are not easily discernable in the new Keynesian (NK) model, which defines a theoretical framework for monetary policy. First, the costs may result from the effects of unconventional monetary policy measures on the intensity of restructuring and the persistence of uncertainty (which increased after the outbreak of the crisis). However, neither of these processes is considered in the new Keynesian model. Second, costs may be generated not only by distortions in the choices made by economic agents but may also be a result of the decisions made by governments, particularly in terms of the fiscal deficit level. However, the new Keynesian model does not consider the effects of unconventional monetary policy measures on the quality of fiscal policy. Without carefully considering the costs, there is a significant risk that unconventional monetary policy measures could become a conventional response to recurrent crises.

Generalizing the Taylor Principle: Reply

2010 ◽  
Vol 100 (1) ◽  
pp. 618-624 ◽  
Author(s):  
Troy Davig ◽  
Eric M Leeper
Keyword(s):  
Monetary Policy ◽  
Regime Switching ◽  
Multiple Solutions ◽  
New Keynesian ◽  
New Keynesian Model ◽  
Keynesian Model ◽  
The One

Farmer, Waggoner, and Zha (2009) (FWZ) show that a new Keynesian model with regime-switching monetary policy can support multiple solutions, appearing to contradict findings in Davig and Leeper (2007) (DL). The explanation is straightforward: FWZ derive solutions using a model that differs from the one to which the DL conditions apply. The FWZ solutions also require that the exogenous driving process is a function of private and policy parameters. This undermines the sharp distinctions among “deep parameters” typical of optimizing models and makes it difficult to ascribe economic interpretations to FWZ's additional solutions. (E12, E31, E43, E52)

scholarly journals Forward Guidance without Common Knowledge

2018 ◽  
Vol 108 (9) ◽  
pp. 2477-2512 ◽  
Author(s):  
George-Marios Angeletos ◽  
Chen Lian
Keyword(s):  
General Equilibrium ◽  
Common Knowledge ◽  
Feedback Loops ◽  
New Keynesian ◽  
New Keynesian Model ◽  
Aggregate Level ◽  
Standard Practice ◽  
Forward Guidance ◽  
Keynesian Model ◽  
Forward Looking

How does the economy respond to news about future policies or future fundamentals? Standard practice assumes that agents have common knowledge of such news and face no uncertainty about how others will respond. Relaxing this assumption attenuates the general equilibrium effects of news and rationalizes a form of myopia at the aggregate level. We establish these insights within a class of games which nests, but is not limited to, the New Keynesian model. Our results help resolve the forward-guidance puzzle, offer a rationale for the front-loading of fiscal stimuli, and illustrate more broadly the fragility of predictions that rest on long series of forward-looking feedback loops. (JEL D82, D83, D84, E12, E23, E52, E62)

scholarly journals Dynamic Debt Deleveraging and Optimal Monetary Policy

2020 ◽  
Vol 12 (2) ◽  
pp. 310-350 ◽  
Author(s):  
Pierpaolo Benigno ◽  
Gauti B. Eggertsson ◽  
Federica Romei
Keyword(s):  
Monetary Policy ◽  
Lower Bound ◽  
New Keynesian ◽  
New Keynesian Model ◽  
Optimal Monetary Policy ◽  
Natural Rate ◽  
Keynesian Model ◽  
Natural Rate Of Interest ◽  
Standard Framework

This paper proposes a postcrisis New Keynesian model that incorporates agent heterogeneity in borrowing and lending with a minimum set of assumptions. Unlike the standard framework, this model makes the natural rate of interest endogenous and dependent on macroeconomic policy. The main application is to study optimal monetary policy at the zero lower bound (ZLB). Such policy succeeds in raising the natural rate of interest by creating an environment that speeds up deleveraging and thus endogenously shortens the crisis and the duration of binding ZLB. Inflation should be front-loaded and should overshoot its long-term target during the ZLB episode. (JEL E12, E31, E32, E43, E52)

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