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In the article The State of New Keynesian Economics: A Partial Assessment, Gali says the following about the monetary policy in DSGE models: "Exogenous changes in monetary policy have nontrivial effects on real variables, not only on nominal ones."

I have 2 quesitons:

  1. Does it come from the fact that prices are rigid in DSGE models? Or that there is imperfect competition?

  2. Without price rigidity or imperfect competition (that is to say having an RCB model rather than a DSGE model), would it mean that any monetary policy shock (or any demand shock) would only cause inflation?

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Does it come from the fact that prices are rigid in DSGE models? Or that there is imperfect competition?

The result that monetary policy can affect real variables itself is due to price stickiness, but the price stickiness in labor markets is caused by market imperfections. Furthermore, assumption on imperfect competition in goods market and thus allowing firms to earn markup also has a role as well but in principle you can have DSGE models with just wage stickiness and labor market imperfections and have NK DSGE model. NK DSGE is not a single model it’s a family of models.

Without price rigidity or imperfect competition (that is to say having an RCB model rather than a DSGE model), would it mean that any monetary policy shock (or any demand shock) would only cause inflation?

  1. In canonical RBC models monetary policy would only change price level. However, there exist some RBC models where the money is non neutral.
  2. RBC is not opposite of DSGE. DSGE stands for dynamic stochastic general equilibrium model. Both RBC and NK models can be DSGE models. With perfect markets you would have RBC DSGE model. RBC is in fact an example of one of the earliest DSGE models (see Christiano et al 2017).
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  • $\begingroup$ Seems like you are saying monetary policies do not affect real variables in RBC models? I don’t think that is true. Both Sidrauski and Clower type models allow for non-superneutral behavior. $\endgroup$
    – erik
    Apr 13, 2022 at 16:52
  • $\begingroup$ @erik hi thanks for pointing that out I edited my answer $\endgroup$
    – 1muflon1 ♦
    Apr 13, 2022 at 16:59
  • $\begingroup$ As pointed out by Arrow (1959), you cannot have price stickiness matter with competitive markets (unless you include other frictions like information frictions). If you were to set your price too low you would go bankrupt due to selling below costs, if you set it too high, nobody would buy from you. Thus, a firm not selecting the competitive price that other producers choose would be driven out of the market. It is the combination of stickiness and non-competitiveness that matters. The same would hold true for wage stickiness. Labor markets need to be non-competitive as well. $\endgroup$
    – jpfeifer
    Apr 14, 2022 at 8:24
  • $\begingroup$ @jpfeifer but I clearly mention in my answer the wage stickiness is caused by imperfect labor markets. I am saying you don’t need imperfect competition in goods market because having wage stickiness (cased by labor market imperfections) in itself is enough $\endgroup$
    – 1muflon1 ♦
    Apr 14, 2022 at 8:32
  • $\begingroup$ Those are two different things. You could have wage stickiness, but with competitive labor markets it would not matter at all. We don't care about the causes for stickiness, we typically assume it (e.g. there are contracts or a Calvo fairy). But we need to assume imperfect competition as well. It is not implied by stickiness and also does not cause the latter. $\endgroup$
    – jpfeifer
    Apr 14, 2022 at 8:41

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