Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/211923 
Authors: 
Year of Publication: 
2002
Series/Report no.: 
Bank of Finland Discussion Papers No. 19/2002
Publisher: 
Bank of Finland, Helsinki
Abstract: 
Despite sound theoretical foundations, a drawback of the New Keynesian model is its inability to generate adequate persistence in the variables it seeks to explain.A common solution is to modify the model to include lagged variables.However, this is unsatisfactory, as many such modifications depart from the microeconomic underpinnings of the original model.This paper presents results from simulation exercises that support the fully forward-looking New Keynesian model.In particular, we show that the exchange rate channel of monetary policy, which has been largely overlooked in existing studies of persistence, is instrumental in generating inflation persistence.However, the combination of full forward-looking behaviour and an open economy is unable to generate sufficient persistence in the output gap. Adding an autocorrelated noise term to the assumption of rational expectations makes the model capable of generating persistence matching that of US inflation, the output gap, and the nominal interest rate, as well as the real exchange rate.
Subjects: 
New Keynesian model
rational expectations
persistence
open economy
JEL: 
E31
E52
Persistent Identifier of the first edition: 
ISBN: 
951-686-799-5
Document Type: 
Working Paper

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