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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

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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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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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  3. 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. [Downloadable!]
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  4. Michael R. Pakko, 2005. "Changing technology trends, transition dynamics and growth accounting," Working Papers 2000-014, Federal Reserve Bank of St. Louis. [Downloadable!]
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  7. V. V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1996. "Expectation Traps and Discretion," NBER Working Papers 5541, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. William T. Gavin & Benjamin D. Keen & Michael R. Pakko, 2007. "Inflation risk and optimal monetary policy," Working Papers 2006-035, Federal Reserve Bank of St. Louis. [Downloadable!]
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  9. Christopher J. Neely, 2004. "The Federal Reserve responds to crises: September 11th was not the first," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 27-42. [Downloadable!]
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