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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. 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.
  2. 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.
  3. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  4. Dupor, Bill, 2001. "Investment and Interest Rate Policy," Journal of Economic Theory, Elsevier, vol. 98(1), pages 85-113, May.
  5. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 861-886, October.
  6. Tommy Sveen & Lutz Weinke, 2006. "Firm-specific capital, nominal rigidities, and the Taylor principle," Working Paper 2006/06, Norges Bank.
  7. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  8. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  9. Woodford, Michael, 2005. "Firm-Specific Capital and the New Keynesian Phillips Curve," MPRA Paper 825, University Library of Munich, Germany.
  10. 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.
  11. 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.
  12. 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.
  13. Marc Paolo Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
  14. 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.
  15. 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.
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Cited by:
  1. Gasteiger, Emanuel, 2011. "Heterogeneous expectations, Taylor rules and the merit of monetary policy inertia," MPRA Paper 31004, University Library of Munich, Germany.
  2. Evans, George W & Honkapohja, Seppo, 2008. "Expectations, Learning and Monetary Policy: An Overview of Recent Rersearch," CEPR Discussion Papers 6640, C.E.P.R. Discussion Papers.
  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. Wolfgang Luhan & Johann Scharler, 2013. "Monetary Policy, Inflation Illusion and the Taylor Principle: An Experimental Study," Working Papers 2013-03, Faculty of Economics and Statistics, University of Innsbruck.
  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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