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The Extended Perturbation Method: New Insights on the New Keynesian Model

Author

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  • Martin M. Andreasen

    (Aarhus University and CREATES)

  • Anders Kronborg

    (Danmarks Nationalbank and CREATES)

Abstract

This paper introduces the extended perturbation method, which improves upon standard perturbation by removing approximation errors under perfect foresight. For the New Keynesian model, we show that standard perturbation generates explosive sample paths because it does not account for the upper bound on inflation as implied by Calvo pricing. In contrast, extended perturbation generates stable dynamics as it enforces this bound. Extended perturbation also adds to existing evidence on downward nominal wage rigidities in the New Keynesian model, as we only find support for this friction when using standard perturbation but not when using the more accurate extended perturbation approximation.

Suggested Citation

  • Martin M. Andreasen & Anders Kronborg, 2017. "The Extended Perturbation Method: New Insights on the New Keynesian Model," CREATES Research Papers 2017-14, Department of Economics and Business Economics, Aarhus University.
    • Handle: RePEc:aah:create:2017-14
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    References listed on IDEAS

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    1. Ales Marsal & Katrin Rabitsch & Lorant Kaszab, 2019. "Trend Inflation Meets Macro-Finance: The Puzzling Behavior of Price Dispersion," Working and Discussion Papers WP 6/2019, Research Department, National Bank of Slovakia.

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    More about this item

    Keywords

    Asymmetric wages; Extended Path; Perturbation method; Stable approximations;
    All these keywords.

    JEL classification:

    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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