Department of Economics

Department of Economics EC 924 Term 2, Winter 2016 Monetary Economics Marija Vukotic Deadline for the electronic submission of this assignment is Wednesday, 16 March, at 3:30pm. You are allowed to work in groups of maximum three people. All answers must be typed. Assignment 2 1. Consider a standard baseline New Keynesian model described in \New Perspectives on Monetary Policy, In ation, and the Business Cycle", by Jordi Gal. (a) Explain the dierence between a traditional backward-looking Phillips curve and the New Keynesian Phillips curve? Write down the expression for the NKPC and provide some intuition behind it. What are the main criticisims of the NKPC? (20 marks) (b) In this model, the nominal interest rate (notice that in this paper it is denoted by rt and not it as in the class notes) can be written in the following way: rt ?? = ?? 1 1 + ! 1X k=1 1 + !k??1 Et fyt+kg + m 1 + (1 ?? m) mt Derive this expression (equation (27) in Gali's paper, notice that it should have ?? on the LHS). (30 marks) (c) To the extent that money growth is positively serially correlated (assume m = 0:5), the nominal rate will necessarily increase in response to a monetary ex- pansion. Under what conditions the liquidity eect, which would imply negative relationship between nominal interest rate and quantity of money in the economy, can be restored? (20 marks) (d) Using Dynare, replicate Figures 3 and 5 from Gali's paper. Explain the results and submit a copy of your dynare .mod le. (30 marks) 1