NK Flashcards
What are the defining features of the NK model?
Monopolistic competition ⇒ firms are price setters, not price takers
Frictions in price setting ⇒ some firms cannot freely set the price they would like
What are the 3 main equations in the NK framework
The dynamic IS curve
Phillips Curve
Policy rule
What is the NK cookbook
Cookbook:
- Set up and solve the household’s problem
- Get the Euler equation and C/W-trade-off
- Log linearize these to get HH intertemporal and intratemporal optimality conditions.
- Set up and final good producer’s problem
- Choose optimal inputs = $Y_{it}$ given CES production technology
- Solve for $Y_{it}$
- Solve for $P_{t}$
- Set up and final intermediate good producer’s problem
- Choose optimal price $P^*$ given the production function
- Rewrite FOC
- LL-FOC to get firm optimality (FO)
- Make assumptions
- Use $P_t$ to derive law of price-setting motion (LPSM)
- LL- LPSM
- Combine FO and LPSM to create PK
- Closing the model with the interest rate rule
- LL-$1/Q_t$
- Summarize and analyse
What is a tailor rule?
\hat i_t = \phi \pi_t + v_t
where i = 1/Q_t
This is how the CB reacts to inflation and sets the interest rate.
Taylor’s original interpretation: ϕ > 1 implies real interest rate rt ≈ it − πt = (ϕ − 1)πt reacts to inflation ⇒ stabilizes inflationary shocks
What are the market clearing conditions in the NK model?
Goods clearing: cˆt = ˆyt
Bonds clearing: bˆt = 0
Labor clearing: yˆt = ˆnt
What are the three equation representation of the NK model?
DIS curve: yˆt = −(ˆit − Etπt+1) + Etyˆt+1
Phillips curve: πt = βEtπt+1 + κyˆt
Policy rule: ˆit = ϕπt + νt
What do we need to think about when studing the three equation version of the NK model?
Although very convenient, these equations mix multiple equilibrium relationships ⇒ hard to extract a precise intuition about model mechanisms. Therefore, when analysing shocks, we should look at the full 8-eq system of equations.
Positive monetary policy shocks are equivalent to……
negative demand shocks
What are conceptually the NK-model, what does it predict and how does it deliver?
Basic NK model = RBC model + monopolistic competition and sticky prices
In contrast to RBC, NK predicts real effects of monetary policy and “demand-driven” fluctuations
Can match evidence on monetary policy qualitatively, but not quantitatively
Which of the eight eq equations are affected by a TFP shock?
Marginal cost: mc ct = ˆωt
Labor clearing: yˆt = ˆnt
What is an surprising result of a TFP shock in the NK-IRF-graphs?
The fall in hours worked
What are the two central assertions of the prevailing Neo-Wicksellian view of
business cycles?
- Monetary factors does not affect the natural real interest
- Inefficient fluctuations are caused by deviations in the real interest rate from the
natural real interest rate
What happens when a TFP shock hits the NK economy with sticky prices
TFP ↑ ⇒ Marginal cost ↓ ⇒ inflation ↓ ⇒ Interest rate ↓
▶Monetary policy “stimulates” the economy…
▶ … but not enough to raise consumption to its efficient level
▶ In the “natural equilibrium”, real interest rate is even lower, and hours worked are
constant (check this at home!)
▶ Therefore, hours decline in the observed equilibrium
What are are the two frictions in the NK model and what inefficiencies do they create?
The basic NK model has two frictions
- Monopolistic competition:
creates a (constant) labor wedge between MRS and MRT - Frictional (Calvo) price setting
Frictional price setting implies time-varying labor wedge and price dispersion
What are the inefficiency in the NK model if we have flexiböe prices?
Higher markup ⇒ lower real wages ⇒ lower production
