Log-linearizing optimal price in New Keynesian model

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In summary, the solution is finding the log-linearized expression for a zero-inflation flexible price steady state and using the steady state values and the formula for the sum of a geometric series.
  • #1
Charlotte87
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Homework Statement


I am going to do a log-linearization around a zero-inflation flexible price steady state of:

[itex]\frac{P_{t}^{*}}{P_{t}}E_{t}\sum_{k=0}^{\infty}\theta^{k}\beta^{k}C_{t+k}^{1-\sigma}\left(\frac{P_{t+k}}{P_{t}}\right)^{\epsilon-1}[/itex]

Zero-inflation flexible price steady state implies that [itex] P_{t} = P^{*}_{t} = P_{t+k} \equiv \bar{P} [/itex].


The Attempt at a Solution



I know the solution is:
[itex]\frac{\bar{C}^{1-\sigma}}{1-\theta\beta} +\frac{\bar{C}^{1-\sigma}}{1-\theta\beta}(\hat{p}^{*}_{t} - \hat{p}_{t}) + \bar{C}^{1-\sigma}\sum_{k=0}^{\infty}\theta^{k}\beta^{k}[(1-\sigma)E_{t}\hat{c}_{t+k} + (\epsilon-1)(E_{t}\hat{p}_{t+k} - \hat{p}_{t})] [/itex]

where [itex] \hat{x}_{t} = x_{t} - \bar{x}, x_{t} = \log(X_{t}), \bar{x} = \log(\bar{X}) [/itex] where [itex] \bar{X} [/itex] is the steady state value of X. And we have used [itex] \sum_{k=0}^{\infty}\theta^{k}\beta^{k} = \frac{1}{1-\theta\beta} [/itex].

I've now tried for several hours to do this approximation, but I just do not get to the solution. Can anyone help me on the way?
 
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  • #2
It is straightforward. Please let me know if you have not figured this out yet, since your post is quite old.
Abe
 

1. What is a Log-linearized optimal price in a New Keynesian model?

A log-linearized optimal price in a New Keynesian model is a mathematical technique used to simplify the equations in the model. By taking the logarithm of the variables, the equations can be transformed into a linear form, making it easier to analyze and solve.

2. Why is log-linearization used in New Keynesian models?

Log-linearization is used in New Keynesian models because it allows for a more accurate representation of the economy. By taking into account the logarithmic relationship between variables, the model can better capture the nonlinearities and complexities of the economy.

3. How does log-linearization impact the optimal price in a New Keynesian model?

Log-linearization has a significant impact on the optimal price in a New Keynesian model. It allows for a better understanding of how changes in variables, such as output and inflation, affect the optimal price and how the central bank can use monetary policy to achieve its target inflation rate.

4. What are the limitations of log-linearization in New Keynesian models?

While log-linearization is a useful tool in simplifying New Keynesian models, it also has its limitations. It assumes that the economy is in a steady state, and any changes are small and temporary. This may not accurately reflect the real-world economy, which experiences larger and more persistent shocks.

5. How does log-linearization differ from other linearization techniques?

Log-linearization differs from other linearization techniques, such as Taylor series approximation, in that it takes the logarithm of the variables rather than approximating them with a linear function. This allows for a more accurate representation of the nonlinear relationship between variables in the model.

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