Continuous Time Versus Discrete Time in the New Keynesian Model: Closed-Form Solutions and Implications for Liquidity Trap

30 Pages Posted: 17 Dec 2018

See all articles by Lilia Maliar

Lilia Maliar

CUNY The Graduate Center - Department of Economics

Date Written: December 2018

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: closed-form solution, continuous time, forward guidance, New Keynesian Model, ZLB. liquidity trap

JEL Classification: C61, C63, C68, E31, E52

Suggested Citation

Maliar, Lilia, Continuous Time Versus Discrete Time in the New Keynesian Model: Closed-Form Solutions and Implications for Liquidity Trap (December 2018). CEPR Discussion Paper No. DP13384, Available at SSRN: https://ssrn.com/abstract=3302624

Lilia Maliar (Contact Author)

CUNY The Graduate Center - Department of Economics ( email )

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New York, NY 10016
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