The Discounted Euler Equation: A Note
We present a simple model with income risk and borrowing constraints which 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 standard DSGE models. We illustrate this with an application to the zero lower bound.
We thank Susanto Basu, Gauti Eggertsson, Marc Giannoni, Fatih Guvenen, Nobuhiro Kiyotaki, Benjamin Moll, Michael Peters, Oistein Roisland, Greg Thwaites, Aleh Tsyvinski, Nicolas Werquin and seminar participants at various institutions for valuable comments and discussions. We thank the National Science Foundation (grant SES-1056107) for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Alisdair McKay & Emi Nakamura & Jón Steinsson, 2017. "The Discounted Euler Equation: A Note," Economica, . citation courtesy of