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Risk and Monetary Policy in a New Keynesian Model

Author

Listed:
  • Mikhail Golosov

    (Princeton University)

  • David Evans

    (University of Oregon)

  • anmol bhandari

    (university of minnesota)

Abstract

Asset pricing data indicates that shocks to the nominal interest rates are primarily reflected in changes in risk premium. In this paper we build a New Keynesian model in which the behavior of interest rates and risk premium is consistent with this observation. We show that monetary shocks affect the real and nominal variables through the novel channel -- when nominal price adjustment is costly, firms need to balance needs to maximize current period profit and minimize future cost of price adjustments. Increase in risk, which follows a decrease in interest rates, increases firm's weight of future costs in inflationary environments, and leads to an increase in inflation, nominal and real marginal costs and output. Effectiveness of monetary policy varies with the state of the economy and generally is low in low inflationary environments. We also show that a number of well-known predictions of New Keynesian models reverses when interest rate shocks affect risk premium.

Suggested Citation

  • Mikhail Golosov & David Evans & anmol bhandari, 2017. "Risk and Monetary Policy in a New Keynesian Model," 2017 Meeting Papers 1359, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:1359
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    References listed on IDEAS

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    Cited by:

    1. Sushant Acharya & Keshav Dogra, 2020. "Understanding HANK: Insights From a PRANK," Econometrica, Econometric Society, vol. 88(3), pages 1113-1158, May.
    2. Guanlong Ren & John Stachurski, 2018. "Dynamic Programming with Recursive Preferences: Optimality and Applications," Papers 1812.05748, arXiv.org, revised Jun 2020.

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