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

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  • Minford, Patrick
  • Srinivasan, Naveen

Abstract

The New-Keynesian Taylor-Rule model of inflation determination with no role for money is incomplete. As Cochrane (2007a, b) argues, it has no credible mechanism for ruling out bubbles (or deal with the non-uniqueness problem that arises when the Taylor principle is violated) and as a result 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 indeterminacy of stable (or unstable paths) 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 dealing with these issues. However it does imply that money cannot be avoided in the new Keynesian set-up, contrary to Woodford (2008).

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7960.

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Date of creation: Aug 2010
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Handle: RePEc:cpr:ceprdp:7960

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Keywords: Determinacy; Money Supply; New-Keynesian; Taylor Rule; Terminal Condition;

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References

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  1. Michael Woodford, 2006. "How Important is Money in the Conduct of Monetary Policy?," Working Papers 1104, Queen's University, Department of Economics.
  2. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  3. John H. Cochrane, 2007. "Determinacy and Identification with Taylor Rules," NBER Working Papers 13409, National Bureau of Economic Research, Inc.
  4. David H. Romer, 2000. "Keynesian Macroeconomics without the LM Curve," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 149-169, Spring.
  5. 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.).
  6. McCallum, Bennett T., 2009. "Inflation determination with Taylor rules: Is new-Keynesian analysis critically flawed?," Journal of Monetary Economics, Elsevier, vol. 56(8), pages 1101-1108, November.
  7. Benjamin Friedman, 2003. "The LM Curve: A Not-So-Fond Farewell," NBER Working Papers 10123, National Bureau of Economic Research, Inc.
  8. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  9. 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.
  10. 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.
  11. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  12. 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.
  13. Maurice Obstfeld & Kenneth Rogoff, 1982. "Speculative Hyperinflations in Maximizing Models: Can We Rule Them Out?," NBER Working Papers 0855, National Bureau of Economic Research, Inc.
  14. 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.
  15. John B. Taylor, 2000. "Teaching Modern Macroeconomics at the Principles Level," American Economic Review, American Economic Association, vol. 90(2), pages 90-94, May.
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Citations

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Cited by:
  1. 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.
  2. 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.
  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. Alho, Kari E.O., 2011. "How to Restore Sustainability of the Euro?," Discussion Papers 1259, The Research Institute of the Finnish Economy.
  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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