MEI Shock: Sticky vs flexible price model

Hi everyone

In a simple RBC model, is it intuitive to have a marginal efficiency of investment (MEI) shock in the specified law of motion of capital with adjustment cost? Most papers I reviewed, I noticed when the MEI shock is considered, it is usually in a NK model framework.

Yeah, I think so. RBC is about perfect competition in goods and inputs markets, and thus the government has no active role in the macro-economy. NK models is about imperfect competition, market failures and the ability of the government to improve macroeconomic condition through fiscal and monetary policies.

Frictions like investment adjustment cost and consumption adjustment cost (habit formation) can be used in both models - RBC and NK. The heart of RBC models is perfect competition. The heart of NK models is imperfect competition…

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MEI shocks are unobservable. For that reason, they are typically estimated from the data. Due to the RBC model featuring monetary non-neutrality, it’s rather implausible as the data generating process. People rather use NK models as they fit the data better. However, for theoretical arguments, an RBC model may be fine.

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