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The Discounted Euler Equation: A Note
Author(s) -
McKay Alisdair,
Nakamura Emi,
Steinsson Jón
Publication year - 2017
Publication title -
economica
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.532
H-Index - 65
eISSN - 1468-0335
pISSN - 0013-0427
DOI - 10.1111/ecca.12226
Subject(s) - simple (philosophy) , zero lower bound , euler equations , shock (circulatory) , economics , forward guidance , new keynesian economics , econometrics , interest rate , risk model , zero (linguistics) , mathematical economics , mathematics , monetary policy , keynesian economics , macroeconomics , mathematical analysis , credit channel , philosophy , linguistics , epistemology , inflation targeting , medicine
We present a simple model with income risk and borrowing constraints that 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 simple New Keynesian models. We illustrate this with an application to the zero lower bound.