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
Date Written: April 2009
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: Suggested Citation