Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework

Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework

Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework

Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework

Excerpt

This book brings together some of the lecture notes that I have developed over the past few years, and which have been the basis for graduate courses on monetary economics taught at different institutions, including Universitat Pompeu Fabra (UPF), Massachusetts Institute of Technology (MIT), and the Swiss Doctoral Program at Gerzensee. The book's main objective is to give an introduction to the New Keynesian framework and some of its applications. That framework has emerged as the workhorse for the analysis of monetary policy and its implications for inflation, economic fluctuations, and welfare. It constitutes the backbone of the new generation of medium-scale models under development at the International Monetary Fund, the Federal Reserve Board, the European Central Bank (ECB), and many other central banks. It has also provided the theoretical underpinnings to the inflation stability-oriented strategies adopted by the majority of central banks in the industrialized world.

41A defining feature of this book is the use of a single reference model throughout the chapters. That benchmark framework, which I refer to as the “basic New Keynesian model,” is developed in chapter 3. It features monopolistic competition and staggered price setting in goods markets, coexisting with perfectly competitive labor markets. The “classical model” introduced in chapter 2, characterized by perfect competition in goods markets and flexible prices, can be viewed as a limiting case of the benchmark model when both the degree of price stickiness and firms' market power vanish. The discussion of the empirical shortcomings of the classical monetary model provides the motivation for the development of the New Keynesian model, as discussed in the introductory chapter.

The implications for monetary policy of the basic New Keynesian model, including the desirability of inflation targeting, are analyzed in chapter 4. Each of the subsequent chapters then builds on the basic model and analyzes an extension of that model along some specific dimension. Once the reader has grasped the contents of chapters 1 through 4, each subsequent chapter can be read independently, and in any order. Thus, chapter 5 introduces a policy tradeoff in the form of an exogenous cost-push shock that serves as the basis for a discussion of the differences between the optimal policy with and without commitment. Chapter 6 extends the assumption of nominal rigidities to the labor market and examines the . . .

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