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Monetary policy as equilibrium selection

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  • Gaetano Antinolfi
  • Costas Azariadis
  • James B. Bullard

Abstract

Can monetary policy guide expectations toward desirable outcomes when equilibrium and welfare are sensitive to alternative, commonly held rational beliefs? This paper studies this question in an exchange economy with endogenous debt limits in which dynamic complementarities between dated debt limits support two Pareto-ranked steady states: a suboptimal, locally stable autarkic state and a constrained optimal, locally unstable trading state. The authors identify feedback policies that reverse the stability properties of the two steady states and ensure rapid convergence to the constrained optimal state.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2007)
Issue (Month): Jul ()
Pages: 331-342

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Handle: RePEc:fip:fedlrv:y:2007:i:jul:p:331-342:n:v.89no.4

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Keywords: Monetary policy ; Equilibrium (Economics);

References

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  1. Randall Wright, 2005. "Introduction to "Models of Monetary Economies II: The Next Generation"," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Oct, pages 2-9.
  2. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 1999. "The Perils of Taylor Rules," CEPR Discussion Papers 2314, C.E.P.R. Discussion Papers.
  3. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  4. Boldrin, Michele & Woodford, Michael, 1990. "Equilibrium models displaying endogenous fluctuations and chaos : A survey," Journal of Monetary Economics, Elsevier, vol. 25(2), pages 189-222, March.
  5. Kehoe, Timothy J & Levine, David K, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 865-88, October.
  6. Azariadis, Costas & Kaas, Leo, 2007. "Asset price fluctuations without aggregate shocks," Journal of Economic Theory, Elsevier, vol. 136(1), pages 126-143, September.
  7. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  8. Stefano Eusepi & Jess Benhabib, 2005. "The Design of Monetary and Fiscal Policy: A Global Perspective," Computing in Economics and Finance 2005 388, Society for Computational Economics.
  9. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
  10. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  11. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  12. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
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Citations

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Cited by:
  1. Gaetano Antinolfi & Costas Azariadis & James B. Bullard, 2007. "The optimal inflation target in an economy with limited enforcement," Working Papers 2007-037, Federal Reserve Bank of St. Louis.
  2. Peter N. Ireland, 2007. "Commentary on "Monetary policy as equilibrium selection"," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 343-348.
  3. Bejan, Camelia & Bidian, Florin, 2010. "Limited enforcement, bubbles and trading in incomplete markets," MPRA Paper 36819, University Library of Munich, Germany, revised 20 Feb 2012.
  4. Patrick A. Pintus, 2008. "Laffer traps and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 165-174.
  5. Gaetano Bloise & Pietro Reichlin & Mario Tirelli, 2013. "Fragility of Competitive Equilibrium with Risk of Default," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(2), pages 271-295, April.

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