Monetary Policy, Inflation, and the Business Cycle

216 Pages·2013·0.97 MB·English

by  Jordi Gali

Monetary Policy, Inflation,
and the Business Cycle
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Monetary Policy, Inflation,
and the Business Cycle
An Introduction to the New Keynesian Framework
JordiGalí
PrincetonUniversityPress
PrincetonandOxford
Copyright©2008byPrincetonUniversityPress
PublishedbyPrincetonUniversityPress,
41WilliamStreet,Princeton,NewJersey08540
IntheUnitedKingdom:PrincetonUniversityPress,
6OxfordStreet,Woodstock,OxfordshireOX201TW
AllRightsReserved
LibraryofCongressCataloging-in-PublicationData
Galí,Jordi,1961–
Monetarypolicy,inflation,andthebusinesscycle:anintroduction
totheNewKeynesianframework/JordiGalí.
p. cm.
Includesbibliographicalreferencesandindex.
ISBN978-0-691-13316-4(hbk.:alk.paper) 1. Monetarypolicy.
2. Inflation(Finance). 3. Businesscycles. 4. Keynesianeconomics. I. Title.
HG230.3.G352008
339.5'3—dc22 2007044381
BritishLibraryCataloging-in-PublicationDataisavailable
ThisbookhasbeencomposedinTimesRomanbyWestchesterBookGroup.
Printedonacid-freepaper.(cid:1)∞
press.princeton.edu
PrintedintheUnitedStatesofAmerica
10 9 8 7 6 5 4 3 2 1
Alsmeuspares
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Contents
Preface ix
1 Introduction 1
2 AClassicalMonetaryModel 15
3 TheBasicNewKeynesianModel 41
4 MonetaryPolicyDesignintheBasicNewKeynesianModel 71
5 MonetaryPolicyTradeoffs:DiscretionversusCommitment 95
6 AModelwithStickyWagesandPrices 119
7 MonetaryPolicyandtheOpenEconomy 149
8 MainLessonsandSomeExtensions 185
Index 195
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Preface
ThisbookbringstogethersomeofthelecturenotesthatIhavedevelopedoverthe
pastfewyears,andwhichhavebeenthebasisforgraduatecoursesonmonetary
economics taught at different institutions, including Universitat Pompeu Fabra
(UPF), Massachusetts Institute of Technology (MIT), and the Swiss Doctoral
Program at Gerzensee. The book’s main objective is to give an introduction to
theNewKeynesianframeworkandsomeofitsapplications.Thatframeworkhas
emergedastheworkhorsefortheanalysisofmonetarypolicyanditsimplications
forinflation,economicfluctuations,andwelfare.Itconstitutesthebackboneofthe
newgenerationofmedium-scalemodelsunderdevelopmentattheInternational
MonetaryFund, theFederalReserveBoard, theEuropeanCentralBank(ECB),
andmanyothercentralbanks.Ithasalsoprovidedthetheoreticalunderpinningsto
theinflationstability-orientedstrategiesadoptedbythemajorityofcentralbanks
intheindustrializedworld.
Adefiningfeatureofthisbookistheuseofasinglereferencemodelthroughout
the chapters. That benchmark framework, which I refer to as the “basic New
Keynesianmodel,”isdevelopedinchapter3.Itfeaturesmonopolisticcompetition
andstaggeredpricesettingingoodsmarkets,coexistingwithperfectlycompetitive
labor markets. The “classical model” introduced in chapter 2, characterized by
perfect competition in goods markets and flexible prices, can be viewed as a
limiting case of the benchmark model when both the degree of price stickiness
andfirms’marketpowervanish.Thediscussionoftheempiricalshortcomingsof
theclassicalmonetarymodelprovidesthemotivationforthedevelopmentofthe
NewKeynesianmodel,asdiscussedintheintroductorychapter.
The implications for monetary policy of the basic New Keynesian model,
includingthedesirabilityofinflationtargeting,areanalyzedinchapter4.Eachof
thesubsequentchaptersthenbuildsonthebasicmodelandanalyzesanextension
of that model along some specific dimension. Once the reader has grasped the
contents of chapters 1 through 4, each subsequent chapter can be read indepen-
dently,andinanyorder.Thus,chapter5introducesapolicytradeoffintheform
of an exogenous cost-push shock that serves as the basis for a discussion of the
differencesbetweentheoptimalpolicywithandwithoutcommitment.Chapter6
extendstheassumptionofnominalrigiditiestothelabormarketandexaminesthe