Macroeconomic Fluctuations with HANK & SAM: an Analytical Approach

New Keynesian models with unemployment and incomplete markets are rapidly becoming a new workhorse model in macroeconomics. Such models typically require heavy computational methods which may obscure intuition and overlook equilibria. We present a tractable version which can be characterized analytically. Our results highlight that –due the interaction between incomplete markets, sticky prices and endogenous unemployment risk –productivity shocks may have radically di¤erent e¤ects than in traditional NK models, that the Taylor principle may fail, and that pessimistic beliefs may be self-ful…lling and move the economy into temporary episodes of low demand and high unemployment, as well as into a long-lasting “unemployment trap”. At the Zero Lower Bound, the presence of endogenous unemployment risk can create in‡ation and overturn paradoxical properties of the model. We further study …nancial asset prices and show that non-negligible risk premia emerge. JEL Classi…cations: E10, E21, E24, E30, E52 Keywords: Sticky prices, incomplete asset markets, matching frictions, multiple equilibria, ampli…cation Ravn: Department of Economics, University College London, Drayton house, 30 Gordon Street, London WC1E 6BT, UK. [email protected]; Sterk: Department of Economics, University College London, Drayton house, 30 Gordon Street, London WC1E 6BT, UK. [email protected]. We are grateful for comments from seminar participants at the Bank of England, Bocconi University, UCL and at UCLA. Financial support from the ADEMU (H2020, No. 649396) project and from the ESRC Centre for Macroeconomics is gratefully acknowledged. Chanwoo Kim provided superb research assistance.