No. 784: On the Mechanics of New-Keynesian Models
February 25, 2016
We scrutinize the monetary transmission mechanism in New-Keynesian models, focusing on the role of capital, the key ingredient in the transition from the basic framework to DSGE models. The widely held view that monetary policy aﬀects output and inﬂation in these models through a real interest rate channel is shown to be misguided. A decline in output and inﬂation is consistent with a decline, increase, or no change in the real interest rate. The expected path of Taylor rule shocks and the New-Keynesian Phillips Curve are key for inﬂation and output; the real rate largely reﬂects consumption smoothing.
J.E.L classification codes: E30, E40, E50
Keywords:New-Keynesian models, Monetary transmission mechanism, Real interest rate channel, Capital