Monetary Policy Indeterminacy and Identification Failures in the US: Results from a Robust Test

We propose a novel robust test to assess whether an estimated new-Keynesian model is consistent with a unique stable solution, as opposed to multiple equilibria. Our strategy is designed to handle identification failures as well as the misspecification of the relevant propagation mechanisms. We invert a likelihood ratio test for the cross-equation restrictions (CER) that the new-Keynesian system places on its reduced form solution under determinacy. If the CER are not rejected, we rule out the occurrence of sunspot-driven expectations from the model equilibrium and accept the structural model. Otherwise, we move to a second-step and invert, using the same grid considered in the first-step, an Anderson and Rubin-type test for the orthogonality restrictions (OR) implied by the system of Euler equations. We accept the hypothesis of indeterminacy if the OR are not rejected. We investigate the finite sample performance of the suggested two-steps testing strategy by some Monte Carlo experiments. Finally, we apply our robust test to a new-Keynesian AD/AS model estimated with actual U.S. post-WWII data. In spite of some evidence of weak identification as for the `Great Moderation' period, our results offer formal support to the hypothesis of a switch from indeterminacy to uniqueness occurred in the late 1970s.