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Monetary policy and natural disasters in a DSGE model: how should the Fed have responded to Hurricane Katrina?

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  • Benjamin D. Keen
  • Michael R. Pakko

Abstract

In the immediate aftermath of Hurricane Katrina, speculation arose that the Federal Reserve might respond by easing monetary policy. This paper uses a dynamic stochastic general equilibrium (DSGE) model to investigate the appropriate monetary policy response to a natural disaster. We show that the standard Taylor (1993) rule response in models with and without nominal rigidities is to increase the nominal interest rate. That finding is unchanged when we consider the optimal policy response to a disaster. A nominal interest rate increase following a disaster mitigates both temporary inflation effects and output distortions that are attributable to nominal rigidities.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2007-025.

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Date of creation: 2007
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Handle: RePEc:fip:fedlwp:2007-025

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Keywords: Monetary policy - United States ; Natural disasters - Economic aspects;

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  1. Fumio Hayashi, 1981. "Tobin's Marginal q and Average a : A Neoclassical Interpretation," Discussion Papers 457, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. V. V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1996. "Expectation Traps and Discretion," NBER Working Papers 5541, National Bureau of Economic Research, Inc.
  3. Michael R. Pakko, 2005. "Changing technology trends, transition dynamics and growth accounting," Working Papers 2000-014, Federal Reserve Bank of St. Louis.
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  6. Gavin, William T. & Keen, Benjamin D. & Pakko, Michael R., 2009. "Inflation Risk And Optimal Monetary Policy," Macroeconomic Dynamics, Cambridge University Press, vol. 13(S1), pages 58-75, May.
  7. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  8. Christopher J. Neely, 2003. "The Federal Reserve responds to crises: September 11th was not the first," Working Papers 2003-034, Federal Reserve Bank of St. Louis.
  9. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
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Cited by:
  1. Eduardo Cavallo & Ilan Noy, 2010. "The Aftermath of Natural Disasters: Beyond Destruction," CESifo Forum, Ifo Institute for Economic Research at the University of Munich, vol. 11(2), pages 25-35, 07.
  2. Eduardo Cavallo & Ilan Noy, 2009. "The Economics of Natural Disasters - A Survey," Working Papers 200919, University of Hawaii at Manoa, Department of Economics.

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