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Investment and Monetary Policy: Learning and Determinacy of Equilibrium

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  • John Duffy
  • Wei Xiao

Abstract

We examine determinancy and expectational stability (learnability) of rational expectations equilibrium (REE) in sticky price New Keynesian (NK) models of the monetary transmission mechanism. We consider three different New Keynesian models: a labor-only model and two models that add capital -- one where capital is allocated in an economy-wide rental market and another where demand for capital is firm-specific. We find that Bullard and Mitra's (2002, 2007) findings on determinacy and learnability of REE under various interest rate rules in the labor-only NK model do not always extend to models with capital. In particular, the Taylor principle, that the response of interest rates should be more than proportionate to changes in inflation, will not generally suffice to guarantee determinate and/or learnable equilibria in NK models with capital.

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Paper provided by University of Pittsburgh, Department of Economics in its series Working Papers with number 324.

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Date of creation: Jul 2007
Date of revision: Aug 2008
Handle: RePEc:pit:wpaper:324

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  1. Tommy Sveen & Lutz Weinke, 2006. "Firm-specific capital, nominal rigidities, and the Taylor principle," Working Paper 2006/06, Norges Bank.
  2. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  3. Bill Dupor, 2000. "Investment and Interest Rate Policy," Econometric Society World Congress 2000 Contributed Papers 0007, Econometric Society.
  4. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  5. Sveen, Tommy & Weinke, Lutz, 2005. "New perspectives on capital, sticky prices, and the Taylor principle," Journal of Economic Theory, Elsevier, vol. 123(1), pages 21-39, July.
  6. Michael Woodford, 2005. "Firm-Specific Capital and the New Keynesian Phillips Curve," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
  7. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  8. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  9. Kurozumi, Takushi & Van Zandweghe, Willem, 2008. "Investment, interest rate policy, and equilibrium stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1489-1516, May.
  10. Marc Paolo Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
  11. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  12. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64.
  13. 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.
  14. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
  15. 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.
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Cited by:
  1. Evans, George & Honkapohja, Seppo, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," SIRE Discussion Papers 2008-03, Scottish Institute for Research in Economics (SIRE).
  2. Wolfgang J. Luhan & Johann Scharler, 2013. "Monetary Policy, Inflation Illusion and the Taylor Principle – An Experimental Study," Ruhr Economic Papers 0402, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  3. Raghbendra Jha & Varsha S. Kulkarni, 2012. "Inflation Volatility and the Inflation-Growth Tradeoff in India," ASARC Working Papers 2012-11, The Australian National University, Australia South Asia Research Centre.
  4. Gasteiger, Emanuel, 2011. "Heterogeneous expectations, Taylor rules and the merit of monetary policy inertia," MPRA Paper 31004, University Library of Munich, Germany.
  5. Raghbendra Jha & Varsha S. Kulkarni, 2013. "Inflation, its Volatility and the Inflation-Growth Tradeoff in India," ASARC Working Papers 2013-06, The Australian National University, Australia South Asia Research Centre.

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