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Determinacy in New Keynesian Models: A Role for Money after All?

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  • Patrick Minford
  • Naveen Srinivasan

Abstract

The New-Keynesian Taylor-Rule model of inflation determination with no role for money is incomplete. As Cochrane (2007a) argues, it has no credible mechanism for ruling out bubbles and as a results fails to provide a reason for private agents to pick a unique stable path. We propose a way forward. Our proposal is in effect that the New-Keynesian model should be formulated with a money demand and money supply function. It should also embody a terminal condition for money supply behaviour. If an unstable path occurred the central bank would switch to a money supply Rule explicitly designed to stop it via the terminal condition. This would be therefore a 'threat/trigger strategy' complementing the Taylor Rule - only to be invoked if inflation misbehaved. Thus we answer the criticisms levelled at the Taylor Rule that it has no credible mechanism for ruling out bubbles. However it does imply that money cannot be avoided int he New Keynesian set-up, contrary to Woodford (2008).

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Article provided by Wiley Blackwell in its journal International Finance.

Volume (Year): 14 (2011)
Issue (Month): 2 (06)
Pages: 211-229

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Handle: RePEc:bla:intfin:v:14:y:2011:i:2:p:211-229

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  1. John B. Taylor, 2000. "Teaching Modern Macroeconomics at the Principles Level," American Economic Review, American Economic Association, vol. 90(2), pages 90-94, May.
  2. Minford, Patrick, 2008. "Commentary on Economic Projections and Rules of Thumb for Monetary Policy (by Athanasios Orphanides and Volker Wieland)," Cardiff Economics Working Papers E2008/16, Cardiff University, Cardiff Business School, Economics Section.
  3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  4. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  5. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February.
  6. Dale W. Henderson & Warwick J. McKibbin, 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," International Finance Discussion Papers 458, Board of Governors of the Federal Reserve System (U.S.).
  7. Patrick Minford & David Peel, 2003. "Optimal monetary policy: is price-level targeting the next step?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 650-667, November.
  8. John H. Cochrane, 2011. "Determinacy and Identification with Taylor Rules," Journal of Political Economy, University of Chicago Press, vol. 119(3), pages 565 - 615.
  9. Michael Woodford, 2006. "How Important is Money in the Conduct of Monetary Policy?," Working Papers 1104, Queen's University, Department of Economics.
  10. Obstfeld, Maurice & Rogoff, Kenneth S., 1983. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," Scholarly Articles 12491027, Harvard University Department of Economics.
  11. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  12. David H. Romer, 2000. "Keynesian Macroeconomics without the LM Curve," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 149-169, Spring.
  13. Benjamin Friedman, 2003. "The LM Curve: A Not-So-Fond Farewell," NBER Working Papers 10123, National Bureau of Economic Research, Inc.
  14. Bennett T. McCallum, 2008. "Inflation Determination with Taylor Rules: Is New Keynesian Analysis Critically Flawed?," NBER Working Papers 14534, National Bureau of Economic Research, Inc.
  15. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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Cited by:
  1. Luca Sessa, 2012. "Economic (in)stability under monetary targeting," Temi di discussione (Economic working papers) 858, Bank of Italy, Economic Research and International Relations Area.
  2. Minford, Patrick & Srinivasan, Naveen, 2012. "Can the learnability criterion ensure determinacy in New Keynesian Models?," Cardiff Economics Working Papers E2012/16, Cardiff University, Cardiff Business School, Economics Section.
  3. Seitz, Franz & Schmidt, Markus A., 2014. "Money in modern macro models: A review of the arguments," OTH im Dialog: Weidener Diskussionspapiere 37, University of Applied Sciences Amberg-Weiden (OTH).
  4. Bennett T. McCallum, 2012. "Determinacy, Learnability, Plausibility, and the Role of Money in New Keynesian Models," NBER Working Papers 18215, National Bureau of Economic Research, Inc.
  5. Alho, Kari E.O., 2011. "How to Restore Sustainability of the Euro?," Discussion Papers 1259, The Research Institute of the Finnish Economy.
  6. Minford, Patrick & Ou, Zhirong & Wickens, Michael, 2012. "Revisiting the Great Moderation: policy or luck?," Cardiff Economics Working Papers E2012/9, Cardiff University, Cardiff Business School, Economics Section, revised Apr 2014.

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