Policy Paradoxes in the New Keynesian Model

41 Pages Posted: 19 Apr 2014

See all articles by Michael T. Kiley

Michael T. Kiley

Board of Governors of the Federal Reserve System

Date Written: February 11, 2014

Abstract

The most common New-Keynesian model -- with sticky-prices -- has potentially implausible implications in a zero-lower bound environment. Fiscal and forward guidance multipliers can be implausibly large. Moreover, the sticky-price model implies that positive supply shocks, such as an increase in productivity, will lower production, and that increased price flexibility can exacerbate such a decline in output (as well as amplifying the effects of other shocks). These results are fragile and disappear under a plausible alternative to sticky prices -- sticky information: Fiscal and monetary multipliers are smaller, positive supply shocks raise output, and greater price flexibility, in the sense of more frequent updating of information, moves the economy's response toward the neoclassical benchmark. These results suggest caution in drawing policy lessons from a single, sticky-price framework. Finally, we highlight how strategies akin to nominal-income targeting can enhance the ability of policymakers to affect demand in sticky-price and sticky-information models.

Keywords: forward guidance, fiscal multiplier, sticky prices, sticky information

JEL Classification: E31, E52, E62, E63

Suggested Citation

Kiley, Michael T., Policy Paradoxes in the New Keynesian Model (February 11, 2014). FEDS Working Paper No. 2014-29. Available at SSRN: https://ssrn.com/abstract=2426184 or http://dx.doi.org/10.2139/ssrn.2426184

Michael T. Kiley (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2448 (Phone)
202-452-5296 (Fax)

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