Review of the Basic New Keynesian Model

Xiaohan Ma

Texas Tech University

[email protected]

Spring 2018

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 1 / 48

The Basic New Keynesian (NK) Model

A benchmark NK model

A large number of identical households, demand for differentiated

products

A large number of monopolistically competitive firms, sticky prices

Nominal and real shocks affecting macroeconomic variables

References:
Textbook ”Monetary Policy, Inflation, and the Business Cycle” by
Jordi Gali
Lecture notes ”The Basic New Keynesian Model” by Drago Bergholt

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 2 / 48

Notation

Little letters denote logarithm (or other proportional variables)

ct ≡ log Ct nt ≡ log Nt at ≡ log At

Bars denote non-stochastic steady state

c̄ ≡ log C̄ n̄ ≡ log N̄ ā ≡ log Ā

where Ā ≡ E {A} (unconditional mean)

Hats denote log deviations from steady state (percentage deviation

from steady state)

ĉt ≡ ct − c̄t n̂t ≡ nt − n̄t ât ≡ at − āt = at

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 3 / 48

Household

Household preferences over aggregate consumption and labor supply

 1−σ
− 1 N 1+ϕ

C
U(C , N; Z ) = − Z
1−σ 1+ϕ

Intertemporal preferences
(∞ )
X
E0 β t U(Ct , Nt ; Zt )
t=0

Flow budget constraint at every date and state

Pt Ct + Qt Bt ≤ Bt−1 + Wt Nt + Dt
R1
where Pt Ct = 0 Pt (i)t C (i)di

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 4 / 48

Household

Utility from a continuum of differentiated goods on interval [0,1]


Z 1 −1
 −1
Ct ≡ Ct (i)  di , >1
0

love-of-variety : utility is concave in C (i), the quantity of good i

consumed by the household (since 0 < −1  < 1)

R1
For a given level of consumption expenditure 0 Pt (i)Ct (i)di = Xt ,
static budget constraint
Z 1
Pt (i)Ct (i)di ≤ Xt
0

for some given nominal income Xt > 0

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 5 / 48

Household
The representative household choose how to allocate consumption
expenditures among different goods

Lagrangian with multiplier λ

Z 1 
−1
 −1  Z 1 
Lt = Ct (i)  di + λt Xt − Pt (i)Ct (i)di
0 0

First order conditions

1 1
Ct (i) : Ct Ct (i)−  = λt Pt (i)
These are for all i ∈ [0, 1]
Marginal rate of substitution between good i and j
Pt (i) −
 
Ct (i)
=
Ct (j) Pt (j)
 is thus the (constant) elasticity of substitution between products
Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 6 / 48
Aggregate price index

Define the aggregate price index Pt such that

Z 1
Pt Ct = Xt = Pt (i)Ct (i)di
0

First order condition becomes

 −
Pt (i)
Ct (i) = Ct
Pt

solution for Pt
1
Z 1  1−
Pt = Pt (i)1− di
0

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 7 / 48

Firm’s production

Production technique

Yt (i) = At Nt (i)1−α

where At is total factor (neutral) productivity.

Nominal (total variable) cost function Ψ(Y ) to produce Y

For example, labor costs Wt Nt with production function Yt = At Nt1−α

implied nominal cost
 1
 1−α
Yt
Ψ(Yt ) = Wt
At
and nominal marginal cost
 α
 1−α
0 1 Wt Yt
Ψ (Yt ) =
1 − α At At

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 8 / 48

Firm’s optimal price setting

Maximize profits by choosing Pt (i), taking demand Ct (i) = Yt (i) as given:

dynamic price setting with sticky prices

Firms have random opportunities to change prices in any given period

with probability θ, firm keeps current price
with probability 1 − θ, firm gets to re-optimize price

Implies average duration of price is 1/(1 − θ) periods

Discrete time version of Calvo (1983)

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 9 / 48

Aside: Law of motion for price level
R  1
1 1−ε di 1−ε
Recall: aggregate price index Pt = 0 Pt (i)

In symmetric equilibrium (technology common to all firms), all firms

that get opportunity set same price Pt∗

Law of motion for the price level, given S(t) ∈ [0, 1] as set of firms
not reoptimizing
"Z # 1
1−

Pt = Pt−1 (i)1− di + (1 − θ)(Pt∗ )1−

S(t)
1
1−
= [θPt−1 + (1 − θ)(Pt∗ )1− ] 1−
Divide both sides by Pt−1
1−
Pt∗

Π1−
t = θ + (1 − θ)
Pt−1
Now need to characterize Pt∗
Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 10 / 48
Firm’s optimal price setting

Let Vt+k|t be nominal profit in period t + k given price Pt∗ set at t

Vt+k|t = Pt∗ Yt+k|t − Ψt+k (Yt+k|t )

−
Pt∗

where Yt+k|t = Pt+k Yt+k

Expected discounted nominal profits

(∞ )
X
Et θk Λt,t+k Vt+k|t
k=0

where Λt,t+k is the nominal stochastic discount factor

UC ,t+1 Pt
Λt,t+k = β k
UC ,t Pt+1

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 11 / 48

Firm’s optimal price setting

Firm reoptimizing in period t chooses Pt∗ to maximize profits

∞
X
θk Et Λt,t+k Vt+k|t

max
∗
Pt
k=0
−
Pt∗

subject to demand constraint Yt+k|t = Pt+k Yt+k

First order condition with respect to Pt∗

∞
X 
θk Et {Λt,t+k Yt+k|t (Pt∗ − ψ )} = 0
 − 1 t+k|t
k=0

where ψt+k|t ≡ Ψ0t+k (Yt+k|t ) is nominal marginal cost

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 12 / 48

Firm’s optimal price setting

Inserting for Λt,t+k and Yt+k , and solve for Pt∗

P∞ −1
 Et { k=0 (θβ)k UC ,t+k Pt+k ψt+k|t Yt+k }
Pt∗ = P∞ −1
−1 Et { k=0 (θβ)k UC ,t+k Pt+k Yt+k }

When flexible prices, θ = 0, ⇒ static price setting


Pt∗ = ψ
 − 1 t|t

−1 referred as (constant) ”desired”, ”natural”, or ”frictionless”
markup

In general, this is not quite a solution

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 13 / 48

Equilibrium

1 demand equals supply for each product i

Ct (i) = Yt (i)

2 labor supply equals labor demand

Z 1
Nt = Nt (i)di
0

3 no bond holding Bt = 0.

4 aggregate output

Z 1 −1
 −1
Yt ≡ Yt (i)  di
0

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 14 / 48

Exogenous shocks

Independent AR(1) processes for policy, technology, and preference shocks

vt+1 = ρv vt + εvt+1 εt+1 ∼ IIDN(0, σv2 )

at+1 = ρa at + εat+1 εt+1 ∼ IIDN(0, σa2 )

zt+1 = ρz zt + εzt+1 εt+1 ∼ IIDN(0, σz2 )

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 15 / 48

Canonical three equation NK model

New Keynesian Phillips curve

πt = βEt {πt+1 } + κỹt

Dynamic IS curve or Euler equation

1
ỹt = − (it − Et {πt+1 } − rtn ) + Et {ỹt+1 }
σ
Monetary policy rule, say

it = ρ + φπ πt + φy ỹt + vt

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 16 / 48

 Appendix I:
How to derive the Phillips curve
and IS curve

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 17 / 48

Log-linearization

Procedure:
1 Take logs
2 Do a first order Taylor expansion about a point (usually a steady state)
Taylor expansion of an arbitrary univariate function f (x)

f 0 (x ∗ ) f 00 (x ∗ ) f 000 (x ∗ )
f (x) = f (x ∗ )+ (x −x ∗ )+ (x −x ∗ )2 + (x −x ∗ )3 +...
1! 2! 3!
where x ∗ is any point in the domain of x
When f (x) is sufficiently smooth, or in the neighborhood of x ∗ , it can
be approximated as

f (x) ≈ f (x ∗ ) + f 0 (x ∗ )(x − x ∗ )

First order approximation of exp(x) around x ≈ 0 is

exp(x) ≈ exp(0) + exp(0)(x − 0) = 1 + x

3 Simplify so that everything is expressed in percentage deviations from

steady state

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 18 / 48

Log-linearization

Recall
x̂t ≡ xt − x̄ ≡ log Xt − log X̄
Some useful equations

Xt = X̄ e x̂t ≈ X̄ (1 + x̂t )

Xt Yt ≈ X̄ Ȳ (1 + x̂t + ŷt )
f (Xt ) ≈ f (X̄ )(1 + η x̂t )
∂f (X̄ ) X̄
where η ≡ ∂ X̄ f (X̄ )

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 19 / 48

Log linearization tricks

Example: products

Z = X αY β ⇒ ẑ = αx̂ + β ŷ

Example: sums

Z = αX + βY ⇒ Z̄ ẑ ≈ αX̄ x̂ + β Ȳ ŷ

Example: smooth functions

Z = f (X , Y ) ⇒ Z̄ ẑ ≈ fX (X̄ , Ȳ )X̄ x̂ + fY (X̄ , Ȳ )Ȳ ŷ

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 20 / 48

Log linearizing aggregate price

Law of motion for price level

1
1−
Pt = [θPt−1 + (1 − θ)(Pt∗ )1− ] 1−
Perfect foresight zero-inflation steady state characterized by
Λt,t+k = β k
Pt∗ Pt P̄
Pt−k = Pt−k = P̄ = 1
Yt+k|t = Ȳ , and ψt+k|t = ψt+k = ψ̄
Actual markups, common to all firms, conincide with frictionless
markup ψ̄
P̄
= (−1)


Log-linear approximation around zero-inflation steady state

pt = θpt−1 + (1 − θ)pt∗

implying
πt = pt − pt−1 = (1 − θ)(pt∗ − pt−1 )
Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 21 / 48
Log linearizing optimal price

Price setting
P∞ −1
 Et { k=0 (θβ)k UC ,t+k Pt+k ψt+k|t Yt+k }
Pt∗ = P∞ −1
−1 Et { k=0 (θβ)k UC ,t+k Pt+k Yt+k }

Log-linear approximation around zero-inflation steady state

(∞ )
X
pt∗ = µ + (1 − θβ)Et (θβ)k [mct+k|t + pt+k ]
k=0

with (frictionless) log markup µ ≡ log M and M ≡ /( − 1), and

mct+k|t is log real marginal cost mct+k|t = log(ψt+k|t /Pt+k )

Firm sets a price that depends on

desired markup
weighted average of current and expected nominal marginal costs
Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 22 / 48
Recall log-linear pricing equations

Law of motion for price level

p̂t = θp̂t−1 + (1 − θ)p̂t∗

Inflation
πt = pt − pt−1 = (1 − θ)(pt∗ − pt−1 )
Price chosen by firms that reoptimize in period t
(∞ )
X
p̂t∗ = (1 − θβ)Et (θβ)k ψ̂t+k|t
k=0

obtained by approximation around a zero inflation steady state

Can also add back steady state terms

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 23 / 48

Algebra for new Keynesian Phillips curve

Step (i): reset price p̂t∗ in terms of future real marginal cost and
future prices

Step (ii): inflation in terms of real marginal cost and expected

inflation
(1 − θ)(1 − θβ)
πt = Θmcˆ t + βEt {πt+1 }
θ
Step (iii): real marginal cost in terms of output gap ỹt ≡ ŷt − ŷtn

Step (iv): inflation in terms of output gap and expected inflation

πt = κỹt + βEt πt+1

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 24 / 48

Step (i): reset price p̂t∗ in terms of future real marginal cost and future
prices

Begin with nominal total cost

  1
Y 1−α
Ψ(Y ) = W
A

Nominal marginal cost

  α
0 1 W Y 1−α
ψ ≡ Ψ (Y ) =
1−α A A

Real marginal cost in log deviations

1
ˆ ≡ ψ̂ − p̂ = ŵ − p̂ −
mc (â − αŷ )
1−α

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 25 / 48

Real marginal cost in period t + k given price set at t
1
ˆ t+k|t ≡ ψ̂t+k|t − p̂t+k = ŵt+k − p̂t+k −
mc (ât+k − αŷt+k|t )
1−α
Real marginal cost in period t + k given price set at t + k
1
ˆ t+k ≡ ψ̂t+k − p̂t+k = ŵt+k − p̂t+k −
mc (ât+k − αŷt+k )
1−α
So
α
ˆ t+k|t − mc
mc ˆ t+k = (ŷ − ŷt+k )
1 − α t+k|t
From demand curve

ŷt+k|t = −(p̂t∗ − p̂t+k ) + ŷt+k

Therefore
α
mc ˆ t+k −
ˆ t+k|t = mc (p̂ ∗ − p̂t+k )
1−α t

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 26 / 48

Back to equation for resetting prices
(∞ )
X
p̂t∗ = (1 − θβ)Et (θβ)k [mc
ˆ t+k|t + p̂t+k ]
k=0

So
(∞  )
X α
p̂t∗ = (1 − θβ)Et (θβ)k + mc
ˆ t+k − (p̂ ∗ − p̂t+k ) + p̂t+k
1−α t
k=0

Solving for p̂t∗ to get

(∞ )
X
p̂t∗ = (1 − θβ)Et (θβ)k [Θmc
ˆ t+k + p̂t+k ]
k=0

1−α
where 0 < Θ ≡ 1−α+α ≤1

This is the end of Step(i)

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 27 / 48
Step (ii): inflation in terms of real marginal cost and expected inflation

Begin by breaking up the sum in the price setting equation

(∞ )
X
p̂t∗ = (1 − θβ)[Θmc
ˆ t + p̂t ] + (1 − θβ)Et (θβ)k [Θmc
ˆ t+k + p̂t+k ]
k=1

Or

p̂t∗ = (1 − θβ)[Θmc ∗
ˆ t + p̂t ] + θβEt {p̂t+1 }
Substract p̂t−1 from both sides and rearrange

p̂t∗ − p̂t−1 = (1 − θβ)Θmc ∗

ˆ t + θβEt {p̂t+1 − p̂t } + p̂t − p̂t−1

Recall that the law of motion for price level implies

πt = (1 − θ)(p̂t∗ − p̂t−1 )

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 28 / 48

Combine the last two equations
(1 − θ)(1 − θβ) 1−α
πt = ˆ t + βEt {πt+1 },
Θmc Θ≡
θ 1 − α + α
Inflation is decreasing in θ and demand elasticity 

Solving forward
(∞ )
X
k (1 − θ)(1 − θβ)
πt = λEt β mc
ˆ t+k , λ≡ Θ>0
θ
k=0

Recall that average markup in the economy is −mc ˆ t and the steady
state or desired markup is −mc ⇒ Inflation will be high when firms
expect average markups to be below the desired level. ⇒ Firms that
get the opportunity will choose a price above the economy’s average
level in order to realign their markup closer to the desired level

This is the end of Step(ii)

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 29 / 48
Step (iii): real marginal cost in terms of output gap.
Begin by solving for flexible price equilibrium to get natural level of output.

Resource constraint
Ct = Yt = At Nt1−α
Household labor supply
Wt
Ntϕ Ctσ =
Pt
Firm price setting (in symmetric equilibrium)
"   α #
 1 Wt Yt 1−α
Pt =
 − 1 1 − α At At

Equivalently
 Wt
(1 − α)At Nt−α =
 − 1 Pt

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 30 / 48

Reduce this to two equations in two unknowns

Ct = At Nt1−α

and
−1
Ntϕ Ctσ = (1 − α)At Nt−α

Take logs and solve to get flexible price equilibrium values
 
1 −1 1−σ
nt = log (1 − α) + at
(1 − α)σ + α + ϕ  (1 − α)σ + α + ϕ

and
 
1 −1 1+ϕ
yt = log (1 − α) + at
(1 − α)σ + α + ϕ  (1 − α)σ + α + ϕ

(this is the natural level of output)

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 31 / 48

Use labor supply condition to write real marginal costs
ˆ t = ŵt − p̂t + αn̂t − ât = ϕn̂t + σ ĉt + αn̂t − ât
mc
Using production function and market clearing
(1 − α)σ + α + ϕ 1+ϕ
mc
ˆ t= ŷt − ât
1−α 1−α
Given natural output in log deviation as
1+ϕ
ŷtn = at
(1 − α)σ + α + ϕ
Therefore we can write
(1 − α)σ + α + ϕ
mc
ˆ t= (ŷt − ŷtn )
1−α
(1 − α)σ + α + ϕ
= (yt − ytn )
1−α
Real marginal cost is proportional to the output gap. This is the end
of Step (iii)
Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 32 / 48
Step (iv): real marginal cost in terms of output gap.

Just plug in the formula above back into expression relating inflation
and real marginal cost

πt = βEt {πt+1 } + κỹt

where
ỹt ≡ ŷt − ŷtn = yt − ytn
and
σ(1 − α) + α + ϕ (1 − θ)(1 − θβ)
κ≡ >0
1 + α( − 1) θ

This is often referred to as the New Keynesian Phillips curve (NKPC)

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 33 / 48

From the log linearized Euler equation

it = ρ + (1 − ρz )zt + σEt {∆yt+1 } + Et {πt+1 }

Define the natural rate of interest

rtn = ρ + (1 − ρz )zt + σEt {∆yt+1
n
}
= ρ + (1 − ρz )zt − σ(1 − ρa )ψya at

Therefore
it = rtn + σEt {∆ỹt+1 } + Et {πt+1 }

And so at last, the dynamic IS curve

1
ỹt = − (it − Et {πt+1 } − rtn ) + Et {ỹt+1 }
σ

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 34 / 48

 Appendix II:
How to solve the model

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 35 / 48

Solving the dynamic equations: general form

Combining the three NK equations,

   
ỹt Et {ỹt+1 }
= AT + BT ut
πt Et {πt+1 }

where
ut = rˆtn − φy ŷtn − vt
n
= −ψya (φy + σ(1 − ρa ))at + (1 − ρz )zt − vt

and    
σ 1 − βφπ 1
At ≡ Ω ; Bt ≡ Ω
σκ κ + β(σ + φy ) κ
1
where Ω ≡ σ+φy +κφπ

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 36 / 48

Solving the dynamic equations: general form

The solution is unique if and only if, AT has both eigenvalues within
the unit circle
Given non-negative (φy , φπ ), a necessary and sufficient condition is

κ(φπ − 1) + (1 − β)φy > 0

Method of undertemined coefficients (guess and verify)

Assume ut follows AR(1), guess solutions are linear in ut

ỹt = ψy ut π˜t = ψπ ut

Impose it into the above equation nd solve for ψy and ψπ

ψy = (1 − βρu )Λu ψπ = κΛu

1
where Λu ≡ (1−βρu )[σ(1−ρu )+φy ]+κ(φπ −ρu ) >0

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 37 / 48

Monetary policy shock

at = z t = 0

ytn and rtn are not affected by monetary policy shock

Given ∂ut /∂vt = −1, it follows

ỹt = −(1 − βρv )Λv vt

and
πt = −κΛv vt
1
where Λv ≡ (1−βρv )[σ(1−ρv )+φy ]+κ(φπ −ρv ) >0

A contractionary monetary policy shock leads to a persistent decline

in output gap and inflation.

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 38 / 48

Recover other variables (1)

Real interest rate

r˜t = rt − rtn = σ(1 − ρv )(1 − βρv )Λv vt = rˆt

Nominal interest rate

iˆt = rˆt + Et {πt+1 } = [σ(1 − ρv )(1 − βρv ) − ρv κ]Λv vt

Note: A contractionary policy shock has ambiguous effects on

nominal interest rate
Employment

1 (1 − βρv )Λv
nt = (yt − at ) = − vt
1−α 1−α

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 39 / 48

Recover other variables (2)

Nominal money growth

mt = pt + yt − ηit
= pt−1 − [(1 − βρv )(1 + ησ(1 − ρv )) + (1 − ηρv )κ]Λv vt
⇒
dmt
= −[(1 − βρv )(1 + ησ(1 − ρv )) + (1 − ηρv )κ]Λv
dvt
If nominal interest rate rises, money growth falls surely
It is a sufficient condition for ”liquidity effect”

All variables return to steady state at rate governed by ρv

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 40 / 48

Quantifying the effects

Parameter values
β = 0.99 quarterly
σ = 1 log utility
ϕ = 5 Frisch elasticity 0.2
α = 1/4 labor share 3/4
 = 9 steady state markup 12.5%
η = 4 coefficient of M2 velocity on i in quarterly data
θ = 3/4 price stickiness of 4 quarters
φπ = 1.5, φy = 0.5/4 Taylor’s original rule
ρv = 0.5 moderately persistent shock
σv = 0.25% policy shock of 25 basis points (1% annualized)

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 41 / 48

Impulse responses to a monetary policy shock

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 42 / 48

Technology shock

vt = zt = 0

ytn and rtn ARE affected by monetary policy shock

Following similar method,

n
ỹt = −σψya (φy + σ(1 − ρa ))(1 − βρa )Λa at

and
n
πt = −ψya (φy + σ(1 − ρa ))κΛa at
1
where Λa ≡ (1−βρa )[σ(1−ρa )+φy ]+κ(φπ −ρa ) >0

A positive technology shock leads to a persistent decline in output

gap and inflation.

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 43 / 48

Recover other variables

Natural rate
rtn = −σψya
n
(1 − ρa )at
Output
yt = ỹt + ytn = ψya
n
κ(φπ − ρa )Λa at
Employment
1
nt = (yt − at )
1 − α 
(1 − σ)κ(φπ − ρa )
= − (φy + σ(1 − ρa ))(1 − βρa ) Λa at
σ(1 − α) + ϕ + α

Note: A positive productivity has ambiguous effects on employment.

σ? φy ?

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 44 / 48

Quantifying the effects

Parameter values
β = 0.99 quarterly
σ = 1 log utility
ϕ = 5 Frisch elasticity 0.2
α = 1/4 labor share 3/4
 = 9 steady state markup 12.5%
η = 4 coefficient of M2 velocity on i in quarterly data
θ = 3/4 price stickiness of 4 quarters
φπ = 1.5, φy = 0.5/4 Taylor’s original rule
ρa = 0.9 highly persistent shock
σa = 1%

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 45 / 48

Impulse responses to a technology shock

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 46 / 48

Preference shock

at = vt = 0

Are ytn and rtn affected by preference shock?

Following similar method,

ỹt =?
and
πt =?

A positive preference shock leads to a RISE or DECLINE in output

gap and inflation?
Other variables?

Xiaohan Ma (TTU) The Basic New Keynesian Model Spring 2018 47 / 48

Impulse responses to a preference shock

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