The Four-Equation New Keynesian Model

Eric Sims (), Jing Cynthia Wu and Ji Zhang

The Review of Economics and Statistics, 2023, vol. 105, issue 4, 931-947

Abstract: This paper develops a New Keynesian model featuring financial intermediation, short- and long-term bonds, credit shocks, and scope for unconventional monetary policy. The log-linearized model reduces to four equations: Phillips and IS curves, as well as policy rules for the short-term interest rate and the central bank's long-bond portfolio (QE). Credit shocks and QE appear in both the IS and Phillips curves. In equilibrium, optimal monetary policy entails adjusting the short-term interest rate to offset natural rate shocks but using QE to offset credit market disruptions. Use of QE significantly mitigates the costs of a binding zero lower bound.

Date: 2023
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Working Paper: The Four Equation New Keynesian Model (2019)
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