Rule-of-thumb consumers in the New Keynesian framework

• Thesis title in Czech: Rule-of-thumb consumers in the New Keynesian framework
• Thesis title in English: Rule-of-thumb consumers in the New Keynesian framework
• Key words: fiscal policy, consumption, dsge models
• English key words: fiscal policy, consumption, dsge models
• Academic year of topic announcement: 2010/2011
• Thesis type: diploma thesis
• Thesis language: angličtina
• Department: Institute of Economic Studies (23-IES)
• Supervisor: PhDr. Jaromír Baxa, Ph.D.
• Author: hidden - assigned by the advisor
• Date of registration: 21.02.2011
• Date of assignment: 21.02.2011
• Date and time of defence: 21.06.2011 00:00
• Venue of defence: IES
• Date of electronic submission: 20.05.2011
• Date of proceeded defence: 21.06.2011
• Opponents: Mgr. Jan Čech

Guidelines

Introduction – a motivation
Literature review: a review of theory and empirical studies concerning the consumption function with liquidity constraints and rule-of-thumb consumers
The model
Calibration
Results, sensitivity analysis
Conclusions

References

Campbell, J. & Mankiw, N. (1989). Consumption, income, and interest rates: Reinterpreting the time series evidence. NBER macroeconomics annual, 185--216.

Coenen, G. & Straub, R. (2004). Non-Ricardian households and fiscal policy in an estimated DSGE model of the euro area. Manuscript, European Central Bank 2.

Deaton, A. (1992). Understanding consumption. Oxford University Press, USA. (ISBN: 0198288247.)

Deaton, A. (1991). Saving and liquidity constraints. Econometrica: Journal of the Econometric Society 59 (5), 1221--1248.

Gali, J., López-Salido, J. & Vallés, J. (2007). Understanding the effects of government spending on consumption. Journal of the European Economic Association 5 (1), 227--270.

Gali, J., López-Salido, J. & Vallés, J. (2004). Rule-of-Thumb Consumers and the Design of Interest Rate Rules.. Journal of Money, Credit & Banking 36 (4), 739--764.

Tagkalakis, A. (2008). The effects of fiscal policy on consumption in recessions and expansions. Journal of Public economics 92 (5-6), 1486--1508.

Woodford, M. (2010). Simple analytics of the government expenditure multiplier.

Preliminary scope of work

The thesis will utilize the standard New Keynesian framework in order to assess the properties of the aggregate variables when non-Ricardian households coexist with Ricardian (intertemporally optimizing) households.
The economy will consist of the two mentioned types of households; a competitive final goods sector and an intermediate goods sector characterized by monopolistic competition and price stickiness (modeled by Calvo pricing); the government which imposes lump sum taxes on households in order to finance transfers to the households and other governmental purchases; monetary authority that pursues monetary policy by setting the nominal interest rates.
The optimality and market clearing conditions will be log-linearized around the steady state which will result in a reduced-form dynamical system consisting of 6 equations. The equations must satisfy certain determinacy conditions in order to provide a unique solution of the dynamical system. These conditions will be described and examined when parameters of the model change. Finally and most importantly, the system will be solved and its dynamics simulated using Dynare package in Matlab.

Preliminary scope of work in English

My thesis will study the impacts of the presence of rule-of-thumb (non-Ricardian) consumers on the behaviour of aggregate variables in the standard New Keynesian framework. The first part of the thesis will review the literature concerning the theory and empirics of consumption function with an emphasis on liquidity constraints, rule-of-thumb consumers and fiscal policy multipliers when the former two phenomena are taken into account. The purpose of the discussion will be to make a case for a need to introduce some form of non-Ricardian households into macroeconomic models, if the models are supposed to replicate and predict the reality sufficiently well, particularly the impacts of fiscal policy on consumption and other aggregate variables.

The second part of the thesis will present a model that incorporates non-Ricardian households into the standard New Keynesian framework. I will follow a model described in Galí et al. (2004), which I will calibrate to the data of the Czech economy. Most of the parameters will be adopted from the literature. However, as the proportion of non-Ricardian households has not been estimated for the Czech economy, I will attempt to estimate it using techniques described in Campbell and Mankiw (1989) and other works.

Since the introduction of non-Ricardian households alters the determinacy conditions of the model so the well known Taylor principle is not sufficient for the uniqueness of equilibria, I will analyze the conditions that must hold in order to obtain a unique solution of the dynamical system.

Finally, I will provide sensitivity analysis in order to show how fiscal multipliers change with respect to changes in the proportion of non-Ricardian households and other parameters, such as price stickiness. The thesis will conclude by an assessment of the model and suggestions of its potential improvements.