The house that Keynes built: Redecorating and overhaul of the monetary policy model

Abstract

The regular economic crisis prompts macroeconomists to revise their  models. The monetary policy is no exception. As a result of the  “Great Recession” in 2007-2009 and  the  COVID-­19 pandemic in 2020-2021, they  were  forced  to refresh a look at the  monetary policy models that define central bank’s short­term interest rate decisions. The principles of the  New Keynesian economics  lie behind  most modern  models of monetary policy. A set of equations based on several  theoretical assumptions and simplifications leads to certain model conclusions. An active work to review the New Keynesian models in the 2020s is under  way. Key improvements include financial sector modeling; replacing rational expectations with  their alternatives, as well  as representative economic  agents with  heterogeneous ones; finding microeconomic foundations for assumptions; and  fiscal  policy  modeling.