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Nonlinear inflation expectations and endogenous fluctuations

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  • Gomes, Orlando

Abstract

The standard new Keynesian monetary policy problem is, in its original presentation, a linear model. As a result, only three possibilities are admissible in terms of long term dynamics: the equilibrium may be a stable node, an unstable node or a saddle point. Fixed point stability (a stable node) is generally guaranteed only under an active monetary policy rule. The benchmark model also considers extremely simple assumptions about expectations (perfect foresight is frequently assumed). In this paper, one inquires how a change in the way inflation expectations are modelled implies a change in monetary policy results when an active Taylor rule is taken. By assuming that inflation expectations are constrained by the evolution of the output gap, we radically modify the implications of policy intervention: endogenous cycles, of various periodicities, and chaotic motion will be observable for reasonable parameter values.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 2842.

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Date of creation: Aug 2006
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Handle: RePEc:pra:mprapa:2842

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Keywords: Monetary policy; Taylor rule; Inflation expectations; Endogenous business cycles; Nonlinear dynamics and chaos;

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  1. Dolado, Juan J. & María-Dolores, Ramón & Ruge-Murcia, Francisco J., 2002. "Non-Linear Monetary Policy Rules: Some New Evidence for the US," CEPR Discussion Papers 3405, C.E.P.R. Discussion Papers.
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