A New Keynesian Model with Endogenous Frictions
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.
|Date of creation:||Jun 2009|
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- Jordi Galí & Mark Gertler & J. David López-Salido, 2007.
"Markups, Gaps, and the Welfare Costs of Business Fluctuations,"
The Review of Economics and Statistics,
MIT Press, vol. 89(1), pages 44-59, November.
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- Galí, Jordi & Gertler, Mark & Lopez-Salido, Jose David, 2003. "Mark-ups, Gaps and the Welfare Costs of Business Fluctuations," CEPR Discussion Papers 4134, C.E.P.R. Discussion Papers.
- Jordi Galí & Mark Gertler & J. David López-Salido, 2005. "Markups, gaps and the welfare costs of business fluctuations," Economics Working Papers 836, Department of Economics and Business, Universitat Pompeu Fabra.
- Eric T. Swanson, 2000. "On signal extraction and non-certainty-equivalence in optimal monetary policy rules," Proceedings, Federal Reserve Bank of San Francisco.
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- Lars E.O. Svensson & Noah M. Williams, 2007. "Bayesian and Adaptive Optimal Policy under Model Uncertainty," NBER Working Papers 13414, National Bureau of Economic Research, Inc.
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