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The New Keynesian Cross: Understanding Monetary Policy with Hand-to-Mouth Households

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  • Bilbiie, Florin Ovidiu

Abstract

The New Keynesian Cross describes aggregate demand through a planned expenditure PE curve and captures a key amplification mechanism and decomposition of heterogeneous-agent New Keynesian (HANK) models � la Kaplan, Moll and Violante, 2015. In response to monetary policy, PE�s shift is the direct effect (intertemporal substitution), while its slope (marginal propensity to consume) is the share of the indirect effect in total. There is amplification (dampening) when hand-to-mouth�s income elasticity to aggregate is more (less) than unity; This elasticity depends chiefly on income (including fiscal re-distribution. The effects are magnified by self-insurance when households are hand-to-mouth only occasionally: the aggregate Euler equation now features discounting (McKay, Nakamura and Steinsson, 2015) when the elasticity of hand-to-mouth income to aggregate is lower than unity, but compounding when larger. This matters most for forward guidance (FG), whose power is reduced in the former case, thus resolving the "FG puzzle" (Del Negro et al, 2013) - but amplified in the latter (Werning, 2015), thus aggravating the puzzle.

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  • Bilbiie, Florin Ovidiu, 2017. "The New Keynesian Cross: Understanding Monetary Policy with Hand-to-Mouth Households," CEPR Discussion Papers 11989, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11989
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    Keywords

    hand-to-mouth; heterogenous agents; aggregate demand; optimal monetary policy; liquidity trap; Keynesian cross; forward guidance.;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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