A New Keynesian Perspective on the Great Recession
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Transcript A New Keynesian Perspective on the Great Recession
A NEW KEYNESIAN
PERSPECTIVE ON
THE GREAT
RECESSION
WRITTEN BY: PETER IRELAND
IN THE JOURNAL OF MONEY, CREDIT
AND BANKING,VOL. 43
Tyler Halberg, Dylan Adler, and Kevin
Reitz
THESIS
In terms of its macroeconomics, does the Great
Recession of 2007-2009 really stand apart from its
two immediate predecessors: the milder recessions
of 1990-1991 and 2001?
BACKGROUND
Recession of 2007-2009
New Keynesian Model
Focus on post-1983 period
Compare the Great Recession of 2007-2009 to:
Milder Recessions of 1990-91 and 2001
Monetary Policy Failed
2007-09 recession had a combination of aggregate demand and supply
disturbances
Difference
Shocks lasted longer and more severe
MODEL
Small-scale model that focuses on three main equations:
The New Keynesian IS Curve
Behavior of a representative household
The New Keynesian Phillips Curve
Optimizing Behavior of monopolistically competitive firms that face explicit costs of nominal price
adjustment
Monetary Policy Rule
How the central bank adjusts the short-term nominal interest rate in response to movements in
output and inflation
Empirical Analysis
Output
Inflation
Short-term nominal interest rate
MODEL (REPRESENTATIVE HOUSEHOLD)
Expected Utility Function
𝐸0
∞
𝑡
𝑡=0 𝛽
𝑎𝑡 𝑙𝑛 𝐶𝑡 − 𝛾𝐶𝑡−1 + 𝑙𝑛 𝑀𝑡 𝑃𝑡 − ℎ𝑡
Monetary policy affects:
Money Supply
Consumption
Household’s Utility
MODEL (REPRESENTATIVE GOODSPRODUCING FIRM)
Maximize Profits
𝑃𝑡
1
𝑌
0 𝑡
𝑖
𝜃𝜃𝑡 −1 𝜃𝑡
Firm’s Real Profits
𝑑𝑖
𝜃𝑡 𝜃𝑡 −1
−
1
𝑃
0 𝑡
𝑖 𝑌𝑡 𝑖 𝑑𝑖
MODEL (CENTRAL BANK)
Variant of the Taylor Rule
Output Growth or Inflation rise or fall below average
FIRST ORDER CONDITIONS
FIRST ORDER CONDITIONS
RESULTS
All three recessions were the result of adverse preference and
technology shocks
Lower bound zero interest rate
Government had to implement a highly restrictive monetary policy
The monetary policy prolonged and intensified the recession
CONCLUSION
In terms of its macroeconomics, does the Great Recession
of 2007-2009 really stand apart from its two immediate
predecessors: the milder recessions of 1990-1991 and
2001?
All three recessions were caused by a combination of aggregate demand
and supply disturbances
The Great Recession had adverse shocks that lased much longer and were
much more severe
Zero lower bound on short-term interest rate
Need more complete and detailed assessment of monetary policymaking
strategy
THREE THINGS TO TAKE AWAY…
Technology and preference shocks were the main causes of each
recession
The zero lower bound nominal interest rates forced the Fed to
implement a strict monetary policy through the Taylor rule, which
prolonged and intensified the recession of 2007-2009
Monetary policy is limited when helping the economy respond
efficiently to supply-side shocks