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When does determinacy imply expectational stability?

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  • James B. Bullard
  • Stefano Eusepi

Abstract

In the recent literature on monetary and fiscal policy design, adoption of policies that induce both determinacy and learnability of equilibrium has been considered fundamental to economic stabilization. We study the connections between determinacy of rational expectations equilibrium, and expectational stability or learnability of that equilibrium, in a general class of purely forward-looking models. We ask what types of economic assumptions drive differences in the necessary and sufficient conditions for the two criteria. We apply our result to a relatively general New Keynesian model. Our framework is sufficiently flexible to encompass lags in information, a cost channel for monetary policy, and either Euler equation or infinite horizon approaches to learning. We are able to isolate conditions under which determinacy does and does not imply learnability, and also conditions under which long horizon forecasts make a clear difference to conclusions about expectational stability. The sharpest result is that informational delays break equivalence connections between determinacy and learnability.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2008-007.

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Date of creation: 2009
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Handle: RePEc:fip:fedlwp:2008-007

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Keywords: Rational expectations (Economic theory);

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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2004. "Optimal Simple and Implementable Monetary and Fiscal Rules," NBER Working Papers 10253, National Bureau of Economic Research, Inc.
  2. Preston, Bruce, 2008. "Adaptive learning and the use of forecasts in monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3661-3681, November.
  3. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  4. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 807-824, October.
  5. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," Working Paper 2003-18, Federal Reserve Bank of Atlanta.
  6. 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.
  7. 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.
  8. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  9. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
  10. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1.
  11. Preston, Bruce, 2006. "Adaptive learning, forecast-based instrument rules and monetary policy," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 507-535, April.
  12. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  13. Stefano Eusepi & Bruce Preston, 2010. "Central Bank Communication and Expectations Stabilization," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(3), pages 235-71, July.
  14. Woodford, Michael, 2003. "Comment on: Multiple-solution indeterminacies in monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1177-1188, July.
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Cited by:
  1. Ichiro Muto, 2008. "Monetary Policy and Learning from the Central Bank's Forecast," IMES Discussion Paper Series 08-E-01, Institute for Monetary and Economic Studies, Bank of Japan.
  2. Martin Ellison & Joseph Pearlman, 2010. "Saddlepath Learning," Economics Series Working Papers 505, University of Oxford, Department of Economics.

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