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References
The role of credit market imperfections for business cycle fluctuations is closely related to the so-called credit channel of the monetary transmission mechanism. For a survey, see Bernanke and Gertler (1995).
Friedman (1989) notes that the characterization of monetary policy as a string is consistent with Romer and Romer’s (1989) approach to measuring the effects of monetary policy and with the pre-Friedman-Schwartz view of monetary policy.
This section draws on Gali et al. (2002a: 3ff.).
See the discussion in Gali et al. (2001: 126Iff.). Taking logarithms, and noting that the marginal rate of substitution between consumption and labor is defined as −UN,t /UC,t, this relation is equivalent to (5.4).
For the discussion on microeconometric evidence on these two parameters see Gali et al. (2002a: 6ff.).
For an extensive discussion of the CES production function see Hansen (1993).
In principle, one could also appeal to nominal wage rigidity to explain the countercyclical behavior of the wage markup. In fact, traditional Keynesian economics emphasized downward rigid nominal wages as an important part of the transmission mechanism of business cycle fluctuations. However, the combination of (moderately) flexible prices with sticky nominal wages implies that real wages move countercyclical. Since empirical evidence tends to reject the hypothesis of a countercyclical behavior of real wages, this implication is an important reason why New Keynesian economics abandoned the assumption of sticky nominal wages in favor of sticky prices. See also the discussion in Mankiw (2001) on this issue.
I am grateful to Mark Gertler for making the revised manuscript of Gali et al. (2002a) available to me.
For the same reason we abstracted from capital in the derivation of the New Keynesian IS curve. Gali et al. (2002a) also emphasize that this specification of the production function allows the possibility of variable capital utilization.
Taking logarithms of the CES production function (5.16) and using a Kmenta approximation yields logYt = logA + vφlogKt + v(1−φ)logLt − ϑ(vφ(1 − φ)/2)(logLt − logKt)2 for our production function. The main difference between this function and (5.23) is the quadratic term. For the derivation of the logarithmic form of the CES function, see Hansen (1993: 23).
The derivation of the welfare function in Gali et al. (2002a) contains a mistake, which is why this section is based on Gali et al. (2002b).
See also the discussion of Lucas’ finding in Romer (1996: 414ff).
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(2005). Introducing Nonlinearities into the New Keynesian Model. In: Monetary Policy and the German Unemployment Problem in Macroeconomic Models. Kieler Studien - Kiel Studies, vol 334. Springer, Berlin, Heidelberg. https://doi.org/10.1007/3-540-37679-8_5
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DOI: https://doi.org/10.1007/3-540-37679-8_5
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