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The New Keynesian Cross: Understanding Monetary Policy with Hand-to-Mouth Households

Florin Bilbiie

No 11989, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The New Keynesian Cross describes aggregate demand through a planned expenditure PE curve and captures a key amplification mechanism and decomposition of heterogeneous-agent New Keynesian (HANK) models � la Kaplan, Moll and Violante, 2015. In response to monetary policy, PE�s shift is the direct effect (intertemporal substitution), while its slope (marginal propensity to consume) is the share of the indirect effect in total. There is amplification (dampening) when hand-to-mouth�s income elasticity to aggregate is more (less) than unity; This elasticity depends chiefly on income (including fiscal re-distribution. The effects are magnified by self-insurance when households are hand-to-mouth only occasionally: the aggregate Euler equation now features discounting (McKay, Nakamura and Steinsson, 2015) when the elasticity of hand-to-mouth income to aggregate is lower than unity, but compounding when larger. This matters most for forward guidance (FG), whose power is reduced in the former case, thus resolving the "FG puzzle" (Del Negro et al, 2013) - but amplified in the latter (Werning, 2015), thus aggravating the puzzle.

Keywords: hand-to-mouth; heterogenous agents; aggregate demand; optimal monetary policy; liquidity trap; Keynesian cross; forward guidance. (search for similar items in EconPapers)
JEL-codes: E21 E31 E40 E44 E50 E52 E58 E60 E62 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
Date: 2017-04
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