Monetary Policy and Natural Disasters in a DSGE Model: How Should the Fed Have Responded to Hurricane Katrina?

FRB of St. Louis Working Paper No. 2007-025A

33 Pages Posted: 28 Jun 2007

See all articles by Benjamin D. Keen

Benjamin D. Keen

University of Oklahoma - Department of Economics

Michael R. Pakko

Arkansas Economic Development Institute

Date Written: April 2009

Abstract

In the immediate aftermath of Hurricane Katrina, speculation arose that the Federal Reserve might respond by easing monetary policy. This paper uses a dynamic stochastic general equilibrium (DSGE) model to investigate the appropriate monetary policy response to a natural disaster. We show that the standard Taylor (1993) rule response in models with and without nominal rigidities is to increase the nominal interest rate. That finding is unchanged when we consider the optimal policy response to a disaster. A nominal interest rate increase following a disaster mitigates both temporary inflation effects and output distortions that are attributable to nominal rigidities.

Keywords: Optimal Monetary Policy, Nominal Rigidities, Natural Disasters, Hurricane Katrina

JEL Classification: E31, E32, E42

Suggested Citation

Keen, Benjamin D. and Pakko, Michael R., Monetary Policy and Natural Disasters in a DSGE Model: How Should the Fed Have Responded to Hurricane Katrina? (April 2009). FRB of St. Louis Working Paper No. 2007-025A, Available at SSRN: https://ssrn.com/abstract=996493 or http://dx.doi.org/10.2139/ssrn.996493

Benjamin D. Keen

University of Oklahoma - Department of Economics ( email )

729 Elm Avenue
Norman, OK 73019-2103
United States

Michael R. Pakko (Contact Author)

Arkansas Economic Development Institute ( email )

2801 South University Avenue
Little Rock, AR 72204
United States
501-569-8541 (Phone)
501-569-8538 (Fax)

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