The Discounted Euler Equation: A Note

17 Pages Posted: 4 Apr 2016 Last revised: 19 Jun 2023

See all articles by Alisdair McKay

Alisdair McKay

Boston University - Department of Economics

Emi Nakamura

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER)

Jon Steinsson

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

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

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

Alisdair McKay (Contact Author)

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States

HOME PAGE: http://people.bu.edu/amckay

Emi Nakamura

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jon Steinsson

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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