Analyzing the implications of a cost-channel in a new keynesian model

Abstract

Through making firms’ marginal cost dependent on the nominal interest rate, I in-troduce a cost-channel into an New-Keynesian framework. Including thereby demandand also supply side effects of monetary policy, a monetary authority faces a trade-offbetween stabilizing inflation and the output gap, when experiencing a shock. I show,that this specification has severe impacts on optimal monetary policy, when the zerolower bound becomes binding. Particularly the economy exits the zero lower bound ata later date when conducting discretionary monetary policy, while it does the oppositewhen pursuing committing monetary policy compared to a non cost-channel economy.