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A New Keynesian Model with Endogenous Frictions

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  • Giese, Guido
  • Wagner, Helmut
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    Abstract

    We develop a New Keynesian model that incorporates rigidities in the ability of households and firms to adjust their utility-efficient / profit-efficient resource allocation in response to shocks. These rigidities reflect the fact that households and firms enter into commitments for several periods of time regarding the allocation of resources limiting their ability to flexibly respond to unforeseen shocks. We show that these rigidities can adversely impact the productivity of firms and households' utility and result in the appearance of higher statistical moments in the demand and supply curves which are not exogenously constant but system-endogenous. As a result, we will derive the appearance of an inflation bias which exists even in the case of an efficient natural output and which cannot be removed by a rule-based monetary policy. Further, we show that monetary policy faces an additional trade-off in managing the friction losses due to inflation uncertainty and output uncertainty.

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    File URL: http://hermes-ir.lib.hit-u.ac.jp/rs/bitstream/10086/17495/1/DP520.pdf
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    Bibliographic Info

    Paper provided by Institute of Economic Research, Hitotsubashi University in its series Discussion Paper Series with number a520.

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    Length: 33 p.
    Date of creation: Jun 2009
    Date of revision:
    Handle: RePEc:hit:hituec:a520

    Note: April 2009
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    1. Galí, Jordi & Gertler, Mark & Lopez-Salido, Jose David, 2002. "Markups, Gaps and the Welfare Costs of Business Fluctuations," CEPR Discussion Papers 3212, C.E.P.R. Discussion Papers.
    2. Noah Williams & Lars E.O. Svensson, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," 2007 Meeting Papers 446, Society for Economic Dynamics.
    3. Eric T. Swanson, 2000. "On signal extraction and non-certainty-equivalence in optimal monetary policy rules," Proceedings, Federal Reserve Bank of San Francisco.
    4. Richard Dennis, 2007. "Model uncertainty and monetary policy," Working Paper Series 2007-09, Federal Reserve Bank of San Francisco.
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