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The Role of "Determinacy" in Monetary Policy Analysis

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  • Keynote Speech by Bennett T. McCallum

    (Carnegie Mellon University and National Bureau of Economic Research (E-mail: bmccallum@cmu.edu))

Abstract

It is well known that the concept of "determinacy"-a single stable solution-plays a major role in contemporary monetary policy analysis. But while determinacy is desirable, other things equal, it is not necessary for a solution to be plausible and is not sufficient for a solution to be desirable. There is a related but distinct criterion of " learnability" that seems more crucial. This paper argues that recognition of information feasibility requires that a candidate solution must, to be plausible, be quantitatively learnable on the basis of information generated by the economy itself. Since a prominent least- squares (LS) learning process is highly "biased" toward learnability, it is reasonable to regard it as a necessary condition for any specific solution to be relevant. This implies that determinacy is not necessary for policy analysis; there may be more than one stable solution, but only one that is LS learnable. Also, determinacy is not sufficient for satisfactory policy analysis; explosive solutions pertaining to nominal variables will not be eliminated by transversality conditions. For these and other reasons, the role of determinacy in monetary policy analysis should be reconsidered and substantially de-emphasized.

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Bibliographic Info

Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 27 (2009)
Issue (Month): 1 (November)
Pages: 25-34

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Handle: RePEc:ime:imemes:v:27:y:2009:i:1:p:25-34

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Keywords: Determinacy; Learnability; Rational expectations; Multiple solutions; Monetary policy;

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  1. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1998. "The perils of Taylor Rules," Departmental Working Papers 199831, Rutgers University, Department of Economics.
  2. Bennett T. McCallum, 2006. "E-Stability vis-a-vis Determinacy Results for a Broad Class of Linear Rational Expectations Models," NBER Working Papers 12441, National Bureau of Economic Research, Inc.
  3. James B. Bullard, 2006. "The learnability criterion and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 203-217.
  4. John H. Cochrane, 2007. "Determinacy and Identification with Taylor Rules," NBER Working Papers 13409, National Bureau of Economic Research, Inc.
  5. Charles T. Carlstrom & Timothy S. Fuerst, 2003. "Investment and interest rate policy: a discrete time analysis," Working Paper 0320, Federal Reserve Bank of Cleveland.
  6. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  7. Robert G. King, 2000. "The new IS-LM model : language, logic, and limits," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 45-103.
  8. Kurozumi, Takushi & Van Zandweghe, Willem, 2008. "Investment, interest rate policy, and equilibrium stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1489-1516, May.
  9. Bray, Margaret, 1982. "Learning, estimation, and the stability of rational expectations," Journal of Economic Theory, Elsevier, vol. 26(2), pages 318-339, April.
  10. Ben S. Bernanke & Michael Woodford, 1997. "Inflation forecasts and monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 653-686.
  11. Cho, Seonghoon & McCallum, Bennett T., 2009. "Another weakness of "determinacy" as a selection criterion for rational expectations models," Economics Letters, Elsevier, vol. 104(1), pages 17-19, July.
  12. Bennett McCallum, . "Multiple-Solution Indeterminacies in Monetary Policy Analysis," GSIA Working Papers 2003-E77, Carnegie Mellon University, Tepper School of Business.
  13. 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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