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An Economical Business-Cycle Model

Listed author(s):
  • Pascal Michaillat

    ()

    (Centre for Macroeconomics (CFM)
    Economics Department London School of Economics (LSE))

  • Emmanuel Saez

    ()

    (Department of Economics University of California-Berkeley)

In recent decades, advanced economies have experienced low and stable inflation and long periods of liquidity trap. We construct an alternative business-cycle model capturing these two features by adding two assumptions to a money-in-the-utility-function model: the labor market is subject to matching frictions, and real wealth enters the utility function. These assumptions modify the two core equations of the standard New Keynesian model. With matching frictions, we can analyze equilibria in which inflation is fixed and not determined by a forward-looking Phillips curve. With wealth in the utility, the Euler equation is modified and we can obtain steady-state equilibria with a liquidity trap, positive inflation, and labor market slack. The model is simple enough to inspect the mechanisms behind cyclical fluctuations and to study the effects of conventional and unconventional monetary and fiscal policies. As a byproduct, the model provides microfoundations for the classical IS-LM model. Finally, we show how directed search can be combined with costly price adjustments to generate a forward-looking Phillips curve and recover some insights from the New Keynesian model.

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File URL: http://www.centreformacroeconomics.ac.uk/Discussion-Papers/2014/CFMDP2014-25-Paper.pdf
File Function: First version, 2014
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Paper provided by Centre for Macroeconomics (CFM) in its series Discussion Papers with number 1425.

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Length: 40 pages
Date of creation: Sep 2014
Handle: RePEc:cfm:wpaper:1425
Contact details of provider: Web page: http://www.centreformacroeconomics.ac.uk/

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  1. Federico Ravenna & Carl E. Walsh, 2009. "Welfare-based optimal monetary policy with unemployment and sticky prices: a linear-quadratic framework," Working Paper Series 2009-15, Federal Reserve Bank of San Francisco.
  2. Heng-fu Zou, 1998. "The spirit of capitalism, social status, money, and accumulation," Journal of Economics, Springer, vol. 68(3), pages 219-233, October.
  3. Pascal Michaillat & Emmanuel Saez, 2014. "Aggregate Demand, Idle Time, and Unemployment," Upjohn Working Papers and Journal Articles 14-214, W.E. Upjohn Institute for Employment Research.
  4. Karl Whelan & Jeremy Rudd, 2005. "Modelling inflation dynamics : a critical review of recent research," Open Access publications 10197/237, School of Economics, University College Dublin.
  5. N. Gregory Mankiw & Ricardo Reis, 2001. "Sticky information versus sticky prices: a proposal to replace the New-Keynesian Phillips curve," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  6. Weinzierl, Matthew Charles & Eggertsson, Gauti B. & Blanchard, Olivier & Mankiw, N. Gregory, 2011. "An Exploration of Optimal Stabilization Policy," Scholarly Articles 11177699, Harvard University Department of Economics.
  7. Pascal Michaillat & Emmanuel Saez, 2013. "A model of aggregate demand and unemployment," LSE Research Online Documents on Economics 51579, London School of Economics and Political Science, LSE Library.
  8. Sandeep Mazumder & Laurence M. Ball, 2011. "Inflation Dynamics and the Great Recession," IMF Working Papers 11/121, .
  9. Pascal Michaillat, 2012. "Do Matching Frictions Explain Unemployment? Not in Bad Times," American Economic Review, American Economic Association, vol. 102(4), pages 1721-1750, June.
  10. Eyster, Erik & Madarász, Kristóf & Michaillat, Pascal, 2014. "The Curse of Inflation," CEPR Discussion Papers 10286, C.E.P.R. Discussion Papers.
  11. Gauti B. Eggertsson, 2011. "What Fiscal Policy is Effective at Zero Interest Rates?," NBER Chapters, in: NBER Macroeconomics Annual 2010, Volume 25, pages 59-112 National Bureau of Economic Research, Inc.
  12. Gauti B. Eggertsson & Paul Krugman, 2012. "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach," The Quarterly Journal of Economics, Oxford University Press, vol. 127(3), pages 1469-1513.
  13. Heng-fu Zou, 1995. "The spirit of capitalism and savings behavior," CEMA Working Papers 79, China Economics and Management Academy, Central University of Finance and Economics.
  14. Rotemberg, Julio J., 2005. "Customer anger at price increases, changes in the frequency of price adjustment and monetary policy," Journal of Monetary Economics, Elsevier, vol. 52(4), pages 829-852, May.
  15. Robert E. Hall, 2011. "The Long Slump," American Economic Review, American Economic Association, vol. 101(2), pages 431-469, April.
  16. Moen, Espen R, 1997. "Competitive Search Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 105(2), pages 385-411, April.
  17. James Tobin, 1991. "Price Flexibility and Output Stability: An Old Keynesian View," Cowles Foundation Discussion Papers 994R, Cowles Foundation for Research in Economics, Yale University, revised Sep 1991.
  18. Julio J. Rotemberg, 1982. "Monopolistic Price Adjustment and Aggregate Output," Review of Economic Studies, Oxford University Press, vol. 49(4), pages 517-531.
  19. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  20. Arthur J. Hosios, 1990. "On The Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Oxford University Press, vol. 57(2), pages 279-298.
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