The Discounted Euler Equation: A Note
17 Pages Posted: 4 Apr 2016 Last revised: 19 Jun 2023
Date Written: March 2016
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.
Suggested Citation: Suggested Citation
McKay, Alisdair and Nakamura, Emi and Steinsson, Jon, The Discounted Euler Equation: A Note (March 2016). NBER Working Paper No. w22129, Available at SSRN: https://ssrn.com/abstract=2758477
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