Persistent Stochastic Shocks in a New Keynesian Model with Uncertainty

Tobias Kranz

No 2016-05, Research Papers in Economics from University of Trier, Department of Economics

Abstract: Both from theoretical and practical viewpoints, I argue that the New Keynesian model's forward-looking IS curve should be derived by quadratic approximation. This leaves uncertainty in the basic three-equation model. After adding exogenous AR(1) processes, I examine the results by numerical simulation. First, I derive a reduced-form solution for the nominal rate of interest which describes the equilibrium behavior under optimal discretion. Focusing on the persistence parameter, the equilibrium will be simulated and compared to the model version containing the certainty equivalence. In a next step, impulse response functions show the adjustments over time after a cost shock. As a result, accounting for uncertainty can lead to lower interest rates of roughly 25 basis points compared to the case without uncertainty.

Keywords: Impulse Response; New Keynesian Model; Persistent Stochastic Shocks; Quadratic Approximation; Simulation; Uncertainty (search for similar items in EconPapers)
JEL-codes: E12 E17 E43 E47 E52 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2016
New Economics Papers: this item is included in nep-mac and nep-ore
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Persistent link: https://EconPapers.repec.org/RePEc:trr:wpaper:201605

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