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Peculiar Results and Theoretical Inconsistency of New Keynesian Models

Kim, Minseong (2014): Peculiar Results and Theoretical Inconsistency of New Keynesian Models.

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Abstract

In this paper, several flaws of the basic no-capital/labor-only New Keynesian model are discussed. Some flaws were left undiscovered because mass of varieties n in Dixit-Stiglitz aggregator is often considered as not affecting overall outcomes. Only when n=1 would ordinary results of the basic New Keynesian model hold. To save the theory, we consider the case where production function exhibits constant return to scale for its input labor, then concludes that linear production function itself leads to other sets of problems. The aforementioned results are proven by checking several limit cases of the basic New Keynesian model, which itself is the limit case model of several New Keynesian models. Then we show some problems with applying transversality condition to consumption Euler equation of the model.

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