Editing New Keynesian economics (section)

==Policy implications==

New Keynesian economists agree with [[New Classical Macroeconomics|New Classical]] economists that in the long run, the [[classical dichotomy]] holds: changes in the [[money supply]] are [[neutrality of money|neutral]]. However, because prices are sticky in the New Keynesian model, an increase in the money supply (or equivalently, a decrease in the interest rate) does increase output and lower unemployment in the short run. Furthermore, some New Keynesian models confirm the non-neutrality of money under several conditions.<ref>{{cite journal |last1=Benchimol |first1=J. |last2=Fourçans |first2=A. |year=2012 |url=https://ideas.repec.org/a/eee/jmacro/v34y2012i1p95-111.html |title=Money and risk in a DSGE framework: A Bayesian application to the Eurozone |journal=[[Journal of Macroeconomics]] |volume=34 |pages=95–111|doi=10.1016/j.jmacro.2011.10.003 |s2cid=153669907 }}</ref><ref>{{cite journal |last=Benchimol |first=J. |year=2015 |url=https://ideas.repec.org/a/sej/ancoec/v821y2015p152-184.html |title=Money in the production function: a new Keynesian DSGE perspective |journal=[[Southern Economic Journal]] |volume=82 |issue=1 |pages=152–184}}</ref>

Nonetheless, New Keynesian economists do not advocate using expansive monetary policy for short run gains in output and employment, as it would raise inflationary expectations and thus store up problems for the future. Instead, they advocate using monetary policy for [[stabilization policy|stabilization]]. That is, suddenly increasing the money supply just to produce a temporary economic boom is not recommended as eliminating the increased inflationary expectations will be impossible without producing a recession.

However, when the economy is hit by some unexpected external shock, it may be a good idea to offset the macroeconomic effects of the shock with monetary policy. This is especially true if the unexpected shock is one (like a fall in consumer confidence) which tends to lower both output and inflation; in that case, expanding the money supply (lowering interest rates) helps by increasing output while stabilizing inflation and inflationary expectations.

Studies of optimal monetary policy in New Keynesian DSGE models have focused on interest rate rules (especially '[[Taylor rule]]s'), specifying how the central bank should adjust the [[nominal interest rate]] in response to changes in inflation and output. (More precisely, optimal rules usually react to changes in the [[output gap]], rather than changes in output ''per se''.) In some simple New Keynesian DSGE models, it turns out that stabilizing inflation suffices, because maintaining perfectly stable inflation also stabilizes output and employment to the maximum degree desirable. Blanchard and Galí have called this property the 'divine coincidence'.<ref>{{cite journal |doi=10.1111/j.1538-4616.2007.00015.x |last1=Blanchard |first1=Olivier |last2=Galí |first2=Jordi |year=2007 |title=Real wage rigidities and the New Keynesian model |journal=Journal of Money, Credit, and Banking |volume=39 |issue=1 |pages=35–65 |url= http://www.nber.org/papers/w11806.pdf}}</ref>

However, they also show that in models with more than one market imperfection (for example, frictions in adjusting the employment level, as well as sticky prices), there is no longer a 'divine coincidence', and instead there is a tradeoff between stabilizing inflation and stabilizing employment.<ref name="blanchardgali_nkunemp">{{cite journal | last1=Blanchard | first1=Olivier |last2=Galí |first2=Jordi | title=A New Keynesian model with unemployment | journal=CFS Working Paper 2007/08 |publisher=Center for Financial Studies, Goethe University, Frankfurt | year=2007 | url=http://www.ifk-cfs.de/fileadmin/downloads/publications/wp/07_08.pdf }}</ref> Further, while some macroeconomists believe that New Keynesian models are on the verge of being useful for quarter-to-quarter quantitative policy advice, disagreement exists.<ref>Federal Reserve Bank of Minneapolis (July 2008). [http://www.minneapolisfed.org/research/wp/wp664.pdf "New Keynesian Models: Not Yet Useful for Policy Analysis"].</ref>

Alves (2014)<ref>{{cite journal |last=Alves |first=S. A. L. |year=2014 |title=Lack of Divine Coincidence in New-Keynesian Models |journal=Journal of Monetary Economics |volume=67 |issue=67 |pages=33–46|doi=10.1016/j.jmoneco.2014.07.002 }}</ref> showed that the divine coincidence does not necessarily hold in the non-linear form of the standard New-Keynesian model. This property would only hold if the monetary authority is set to keep the inflation rate at exactly 0%. At any other desired target for the inflation rate, there is an endogenous trade-off, even under the absence real imperfections such as sticky wages, and the divine coincidence no longer holds.