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Determinacy in New Keynesian models: a role for money after all?

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  • Minford, Patrick

    ()
    (Cardiff Business School)

  • Srinivasan, Naveen

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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Bibliographic Info

Paper provided by Cardiff University, Cardiff Business School, Economics Section in its series Cardiff Economics Working Papers with number E2009/21.

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Length: 25 pages
Date of creation: Oct 2009
Date of revision: Apr 2011
Handle: RePEc:cdf:wpaper:2009/21

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Keywords: New-Keynesian; Taylor Rule; Determinacy;

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  1. 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.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  3. 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.
  4. 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.
  5. John B. Taylor, 2000. "Teaching Modern Macroeconomics at the Principles Level," American Economic Review, American Economic Association, vol. 90(2), pages 90-94, May.
  6. Woodford, Michael, 2007. "How Important is Money in the Conduct of Monetary Policy?," CEPR Discussion Papers 6211, C.E.P.R. Discussion Papers.
  7. John H. Cochrane, 2007. "Determinacy and Identification with Taylor Rules," NBER Working Papers 13409, National Bureau of Economic Research, Inc.
  8. David Romer, 2000. "Keynesian Macroeconomics without the LM Curve," NBER Working Papers 7461, National Bureau of Economic Research, Inc.
  9. Maurice Obstfeld & Kenneth Rogoff, 1981. "Speculative hyperinflations in a maximizing models: can we rule them out?," International Finance Discussion Papers 195, Board of Governors of the Federal Reserve System (U.S.).
  10. 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.).
  11. Benjamin Friedman, 2003. "The LM Curve: A Not-So-Fond Farewell," NBER Working Papers 10123, National Bureau of Economic Research, Inc.
  12. Obstfeld, Maurice & Rogoff, Kenneth S., 1983. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," Scholarly Articles 12491027, Harvard University Department of Economics.
  13. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  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.
  16. 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.
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Citations

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Cited by:
  1. Alho, Kari E.O., 2011. "How to Restore Sustainability of the Euro?," Discussion Papers 1259, The Research Institute of the Finnish Economy.
  2. Minford, Patrick & Srinivasan, Naveen, 2012. "Can the learnability criterion ensure determinacy in New Keynesian Models?," CEPR Discussion Papers 9039, C.E.P.R. Discussion Papers.
  3. 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.
  4. 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).
  5. 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.
  6. 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.

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