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  • Cited by 40
  • Print publication year: 2003
  • Online publication date: January 2010

5 - New Perspectives on Monetary Policy, Inflation, and the Business Cycle

Summary

INTRODUCTION

In recent years, the field of macroeconomics has witnessed the development of a new generation of small-scale monetary business cycle models, generally referred to as New Keynesian (NK) models or New Neoclassical Synthesis models. The new models integrate Keynesian elements (imperfect competition, and nominal rigidities) into a dynamic general equilibrium framework that until recently was largely associated with the Real Business Cycle (RBC) paradigm. They can be used (and are being used) to analyze the connection among money, inflation, and the business cycle, and to assess the desirability of alternative monetary policies.

In contrast with earlier models in the Keynesian tradition, the new paradigm has adopted a dynamic general equilibrium modeling approach. Thus, equilibrium conditions for aggregate variables are derived from optimal individual behavior on the part of consumers and firms, and are consistent with the simultaneous clearing of all markets. From that viewpoint, the new models have much stronger theoretical foundations than traditional Keynesian models.

In addition, the emphasis given to nominal rigidities as a source of monetary nonneutralities also provides a clear differentiation between NK models and classical monetary frameworks. In the latter, the key mechanism through which money may have some real effect is the so-called inflation tax. However, those effects are generally acknowledged to be quantitatively small and not to capture the main sources of monetary nonneutralities at work in actual economies.

The purpose of the present paper is twofold. First, it tries to provide an overview of some of the recent developments in the literature on monetary policy in the presence of nominal rigidities.