Working Paper: NBER ID: w22129
Authors: Alisdair McKay; Emi Nakamura; J. N. Steinsson
Abstract: We present a simple model with income risk and borrowing constraints which yields a “discounted Euler equation.” This feature of the model mutes the extent to which news about far future real interest rates (i.e., forward guidance) affects current outcomes. We show that this simple model approximates the outcomes of a rich model with uninsurable income risk and borrowing constraints in response to a forward guidance shock. The model is simple enough to be easily incorporated into standard DSGE models. We illustrate this with an application to the zero lower bound.
Keywords: Discounted Euler Equation; Forward Guidance; Monetary Policy; Income Risk; Borrowing Constraints
JEL Codes: E21; E40; E50
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| future real interest rates (E43) | current consumption (E20) |
| income risk and borrowing constraints (G51) | muted effects of forward guidance on consumption (E21) |
| future interest rates (E43) | consumption (moderated by model features) (D12) |
| high-productivity households' consumption (D10) | cyclically sensitive (E32) |
| low-productivity households' consumption (D19) | muted response to interest rate changes (E43) |