Working Paper: CEPR ID: DP13384
Authors: Lilia Maliar
Abstract: Economists often use interchangeably the discrete- and continuous-time versions of the Keynesian model. In the paper, I ask whether or not the two versions effectively lead to the same implications. I analyze several alternative monetary policies, including a Taylor rule, discretionary interest rate choice and forward guidance. I show that the answer depends on a specific scenario and parameterization considered. In particular, in the presence of liquidity trap, the discrete-time analysis helps overcome some negative implications of the continuous-time model, such as excessively strong impact of price stickiness on inflation and output, unrealistically large government multipliers, as well as implausibly large effects of forward guidance.
Keywords: Forward Guidance; Continuous Time; New Keynesian Model; ZLB; Liquidity Trap; Closed-Form Solution
JEL Codes: C61; C63; C68; E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Price Stickiness (E31) | Inflation (E31) |
| Price Stickiness (E31) | Output (Y10) |
| Forward Guidance (F17) | Output (Y10) |
| Government Spending (H59) | Output (Y10) |
| Government Spending (H59) | Inflation (E31) |
| Discrete-Time Model (C22) | Mitigates Impact of Price Stickiness on Output (E31) |
| Continuous-Time Model (C32) | Large Government Multipliers (E62) |
| Liquidity Trap (E43) | More Plausible Behavior of Output and Inflation Dynamics in Discrete-Time Model (E19) |