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Inflation Determination with Taylor Rules: Is New Keynesian Analysis Critically Flawed?

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  • Bennett T. McCallum

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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Publication status: published as 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.
Handle: RePEc:nbr:nberwo:14534

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  7. Taylor, John B., 1999. "The robustness and efficiency of monetary policy rules as guidelines for interest rate setting by the European central bank," Journal of Monetary Economics, Elsevier, Elsevier, vol. 43(3), pages 655-679, June.
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  9. Marvin Goodfriend, 2007. "How the World Achieved Consensus on Monetary Policy," NBER Working Papers 13580, National Bureau of Economic Research, Inc.
  10. 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.
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  16. Bennett T. McCallum, 2001. "Monetary policy analysis in models without money," Review, Federal Reserve Bank of St. Louis, Federal Reserve Bank of St. Louis, issue Jul, pages 145-164.
  17. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1908, C.E.P.R. Discussion Papers.
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Cited by:
  1. Airaudo, Marco & Nisticò, Salvatore & Zanna, Luis-Felipe, 2012. "Learning, Monetary Policy and Asset Prices," School of Economics Working Paper Series, LeBow College of Business, Drexel University 2012-12, LeBow College of Business, Drexel University.
  2. 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.
  3. Minford, Patrick & Srinivasan, Naveen, 2010. "Determinacy in New Keynesian Models: a role for money after all?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7960, C.E.P.R. Discussion Papers.
  4. Minford, Patrick & Srinivasan, Naveen, 2011. "Ruling out unstable equilibria in New Keynesian models," Economics Letters, Elsevier, Elsevier, vol. 112(3), pages 247-249, September.
  5. Gasteiger, Emanuel, 2011. "Heterogeneous expectations, Taylor rules and the merit of monetary policy inertia," MPRA Paper 31004, University Library of Munich, Germany.
  6. Blake, Andrew P., 2012. "Determining optimal monetary speed limits," Economics Letters, Elsevier, Elsevier, vol. 116(2), pages 269-271.
  7. Michael T. Belongia & Peter N. Ireland, 2012. "The Barnett Critique After Three Decades: A New Keynesian Analysis," NBER Working Papers 17885, National Bureau of Economic Research, Inc.
  8. Balfoussia, Hiona & Brissimis, Sophocles & Delis, Manthos D, 2011. "The theoretical framework of monetary policy revisited," MPRA Paper 32236, University Library of Munich, Germany.
  9. Cochrane, John H., 2009. "Can learnability save new-Keynesian models?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 56(8), pages 1109-1113, November.
  10. Airaudo, Marco, 2013. "Monetary policy and stock price dynamics with limited asset market participation," Journal of Macroeconomics, Elsevier, Elsevier, vol. 36(C), pages 1-22.

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