News Shocks, Monetary Policy, and Amplification Effects in New Keynesian Macroeconomics

Offick, Sven

This thesis contributes to the existing theoretical and empirical literature on New Keynesian Macroeconomics in the field of news (i.e. anticipated) shocks and internal amplification effects in conjunction with and without (optimal) monetary policy. The main contributions are as follows: First, we derive an exact solution formula for lag polynomial associated with news shocks. From the properties of these solutions, it follows that the destabilizing effects of news shocks are not related to the problem of nonfundamentalness. Second, we study the volatility implications of news shocks under optimal monetary policy and boundedly rational expectations. We find that the effects of news shocks on the economy and their importance for business cycle fluctuations rely on the assumption of forward-looking rational expectations. Under bounded rationality, news shocks may generate less volatility than unanticipated shocks of the same form. Third, we introduce partially anticipated monetary policy shocks for which the public has imperfect information about the shock process. We find that this type of shock may lead to a lower volatility than fully anticipated shocks of the same form. Fourth, we integrate a money and credit market into a baseline New Keynesian model based on a money-and-credit-in-the-utility approach. This framework enables us to study changes in the monetary base and in the refinancing rate. It gives implicitly rise to a credit channel as an additional transmission mechanism of monetary shocks in which the (current and future) bond and loan rate directly affect current goods demand. Finally, we estimate a medium-scale real business cycle model with endogenous firm entry for the U.S. economy in order to quantify the amplification mechanism associated with firm entry. The amplification mechanism works through the competition and the variety effect. Both effects are statistically significant and substantially amplify the volatility in output and consumption.

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Offick, Sven: News Shocks, Monetary Policy, and Amplification Effects in New Keynesian Macroeconomics. 2015.

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