overview of the NK model Flashcards
what is the new keynsian model?
it is a workhorse model for much of modern macroeconomics and was adopted by central banks around the world
a simple framework to think about the relationship between monetary policy, inflation and the business cycle
what did NK model add to the standard RBC framework?
1) introduction of nominal variables such as prices, nominal wages, nominal interest rates
2) departure from the assumption of perfect competition on the goods market - there are now postive markups
3) introduction of nominal rigidities - only a constant fraction of firms drawn randomly are allowed to adjust price of their good each period and there is imperfect competition in the labour market
4) monetary policy and inflation are inherent parts of the model
how is the profit maximising condition been rewritten?
the profit maximising condition is rewritten as
MC * e/(e-1) where e is the price elasticity of demand
what is the size of the markup?
e/(e-1) which is greater than 1
if the demand is elastic, what is the markup?
the markup will be small, as the price elasticity of demand tends to infintity then the firm is back to perfect competition where the markup is equal to zero
what are the two key types of nominal rigidities?
price stickiness
wage stickiness
what are the sources of stickiness
monopolistic competition - firms produce differentiated goods with some degree of market power ie price setters
menu costs- costs of changing prices may prevent firms from changing prices often
does a temporary wrong price effect profit much for the NK model, explain?
ince competition is not perfect, having the wrong price temporarily won’t affect the
firm’s profit much =⇒ the firm will change prices when demand or costs of production
change enough to warrant the price change
do firms change price simultaneously in the NK model, explain?
irms do not change prices simultaneously =⇒ the adjustment of the overall
price level takes time. This mechanism is simpler to model, compared to the menu cost!
what does the data from Nakamura and steinsson 2008 say about price stickiness?
the micro data says that sticky prices last for 8-11 months
what is the equation for the dynamic IS curve in the NK-DSGE model?
Y˜t = E_tY˜_(t+1) − (1/σ)[i_t − E_tπ_(t+1) − r∗_t]
where Y˜_t is the output gap in period t
E_tY˜(t+1) is the rationally expected output gap of the future period
E_t*π_(t+1) is the rationally expected inflation of the future period
i_t is the nominal interest rate
r∗_t is the natural real interest rate
1/σ is the coefficient of elasticity of intertemporal substitution: a percentage change in
the ratio of future to current consumption relative to a one percent change in the real interest rate
what is the equation of the NK phillips curve?
π_t=bE_tπ_(t+1) + k*Y˜_t `
what is the equation in period t a function of?
the rate of expected inflation next period multiplied by the discount factor b
output gap which is multiplied by a constant k, which depends on the share of the firms able to change their price and the discount factor
what does the NKPC do?
it is the result of a model of inflation which incorporates price stickiness and the forward looking behaviour of firms
what is the equation of the taylor rule of the NK model?
i_t = γ_ππ_t + γ_Y Y˜_t + r*_t
where γ_π and γ_Y are coefficients showing the degree of the central banks aversion to inflation gap and output gap correspondingly
