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New Keynesian Models, Puzzles and Omitted Effects

Author

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  • Francesco Morelli

    (Link Campus University)

Abstract

The modern macroeconomic debate grapples with explaining complex phenomena, often giving rise to theoretical and empirical puzzles. In response, New Keynesian models have evolved, incorporating frictions and agent heterogeneity, leading to the development of TANK and HANK frameworks. However, increasing model complexity does not always clarify underlying causes. This work introduces a New Keynesian model with Omitted Effects, incorporating previously unaccounted-for variables into agents’ objective functions. Similar to Omitted Variable Bias in econometrics, neglecting key variables in a general equilibrium setting leads to model misspecification and puzzling anomalies. The study follows both theoretical and empirical approaches: first, demonstrating how Omitted Effects address the Forward Guidance Puzzle and the consumption response to government spending; second, using an algorithm to identify omitted variables that improve model fit to US data. Empirical findings highlight the crucial role of real wages, inflation, and income Omitted Effects in resolving key macroeconomic inconsistencies. This framework enhances DSGE models’ flexibility, providing a systematic tool to refine economic modeling and deepen the understanding of macroeconomic dynamics.

Suggested Citation

  • Francesco Morelli, 2025. "New Keynesian Models, Puzzles and Omitted Effects," CEIS Research Paper 604, Tor Vergata University, CEIS, revised 20 Jun 2025.
  • Handle: RePEc:rtv:ceisrp:604
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    References listed on IDEAS

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    1. Nakata, Taisuke & Ogaki, Ryota & Schmidt, Sebastian & Yoo, Paul, 2019. "Attenuating the forward guidance puzzle: Implications for optimal monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 105(C), pages 90-106.
    2. Joseph E. Stiglitz, 1984. "Theories of Wage Rigidity," NBER Working Papers 1442, National Bureau of Economic Research, Inc.
    3. Gabaix, Xavier & Laibson, David, 2017. "Myopia and Discounting," CEPR Discussion Papers 11914, C.E.P.R. Discussion Papers.
    4. Xavier Gabaix, 2020. "A Behavioral New Keynesian Model," American Economic Review, American Economic Association, vol. 110(8), pages 2271-2327, August.
    5. Gauti B. Eggertsson & Michael Woodford, 2003. "Optimal Monetary Policy in a Liquidity Trap," NBER Working Papers 9968, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

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    Keywords

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    JEL classification:

    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • E27 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation: Models and Applications
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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