Solution of a Basic New-Keynesian Model

Abstract

In this paper I solve a basic New Keynesian model, whose the more complexextensions are widely used in recent years for the analysis of monetary policy,fluctuations, and welfare. A canonical form of the NK approach, that it will bepresented below, departs from the assumptions of the classical monetary economy andtherefore the monetary policy neutrality breaks down. First, imperfect competition inthe goods market is introduced by assuming that each firm produces a differentiatedgood and sets its price (instead of taking the price as given). Second, some constraintsare imposed on the price adjustment mechanism by assuming that only a fraction offirms can reset their prices in any given period. In particular, a model of staggeredprice setting a la Calvo (1983) is adopted, which is characterized by random pricedurations.