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Abstract

Cochrane (2007) has strongly questioned the basic economic logic of current mainstream monetary policy analysis, arguing that the standard notion --that "determinacy" of a rational expectations (RE) equilibrium suffices to imply that stable inflation behavior will be generated -- is incorrect. This is because New Keynesian (NK) models are typically consistent with the existence of RE paths with explosive inflation rates (in addition to one or more stable paths) that normally do not imply explosions in real variables relevant for transversality conditions. Consequently, the usual logic does not imply the absence of explosive inflation. That result does not, however, justify negative conclusions about NK analysis. For there is a different criterion that is logically satisfactory for the purpose at hand. This is the requirement that, to be plausible, a RE solution must satisfy the property of least-squares learnability. Adoption of this criterion, which should be attractive to analysts concerned with actual monetary policy, serves to justify in principle the bulk of current mainstream analysis.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14534.

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Date of creation: Dec 2008
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Handle: RePEc:nbr:nberwo:14534

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Find related papers by JEL classification:

• E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
• E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
• E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

This paper has been announced in the following NEP Reports:

• NEP-ALL-2008-12-14 (All new papers)
• NEP-CBA-2008-12-14 (Central Banking)
• NEP-MAC-2008-12-14 (Macroeconomics)
• NEP-MON-2008-12-14 (Monetary Economics)

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Cited by:

1. Minford, Patrick & Srinivasan, Naveen, 2010. "Determinacy in New Keynesian Models: a role for money after all?," CEPR Discussion Papers 7960, C.E.P.R. Discussion Papers.
   
   • Minford, Patrick & Srinivasan, Naveen, 2009. "Determinacy in New Keynesian models: a role for money after all?," Cardiff Economics Working Papers E2009/21, Cardiff University, Cardiff Business School, Economics Section, revised Apr 2011.
2. Minford, Patrick & Srinivasan, Naveen, 2011. "Ruling out unstable equilibria in New Keynesian models," Economics Letters, Elsevier, vol. 112(3), pages 247-249, September.
3. Hiona Balfoussia & Sophocles N. Brissimis & Manthos D. Delis, 2011. "The theoretical framework of monetary policy revisited," Working Papers 138, Bank of Greece.
   
   • Balfoussia, Hiona & Brissimis, Sophocles & Delis, Manthos D, 2011. "The theoretical framework of monetary policy revisited," MPRA Paper 32236, University Library of Munich, Germany.
4. Mahir Binici & Yin-Wong Cheung, 2011. "Exchange Rate Dynamics under Alternative Optimal Interest Rate Rules," CESifo Working Paper Series 3577, CESifo Group Munich.
   
   • Mahir Binici & Yin-Wong Cheung, 2011. "Exchange Rate Dynamics Under Alternative Optimal Interest Rate Rules," Working Papers 362011, Hong Kong Institute for Monetary Research.
   • Mahir Binici & Yin-Wong Cheung, 2011. "Exchange Rate Dynamics under Alternative Optimal Interest Rate Rules," Working Papers 1116, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
5. John H. Cochrane, 2009. "Can Learnability Save New-Keynesian Models?," NBER Working Papers 15459, National Bureau of Economic Research, Inc.
   
   • Cochrane, John H., 2009. "Can learnability save new-Keynesian models?," Journal of Monetary Economics, Elsevier, vol. 56(8), pages 1109-1113, November.
6. Gasteiger, Emanuel, 2011. "Heterogeneous expectations, Taylor rules and the merit of monetary policy inertia," MPRA Paper 31004, University Library of Munich, Germany.

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