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Heterogeneous expectations, Taylor rules and the merit of monetary policy inertia

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  • Gasteiger, Emanuel

Abstract

We present new results for the performance of Taylor rules in a New Keynesian model with heterogeneous expectations. Agents have either rational or adaptive expectations. We find that depending on the particular rule, expectational heterogeneity can create or increase the set of policies that leads to local explosiveness. This is a new level of destabilization compared to what is known. In addition, we demonstrate that policy inertia is an effective tool to safeguard the economy against local explosiveness. Thus, we provide a rationalization for central banks to adjust interest rates with notable inertia in response to shocks.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 31004.

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Date of creation: 10 May 2011
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Handle: RePEc:pra:mprapa:31004

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Keywords: Monetary Policy; Taylor Rules; Heterogeneous Expectations;

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  1. 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.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  3. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  4. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  5. George Evans, 2005. "The design of monetary and fiscal policy: a global perspective - comments," Proceedings, Federal Reserve Bank of San Francisco.
  6. John H. Cochrane, 2007. "Determinacy and Identification with Taylor Rules," NBER Working Papers 13409, National Bureau of Economic Research, Inc.
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  8. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
  9. 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.
  10. Bruce McGough & Glenn D. Rudebusch & John C. Williams, 2004. "Using a long-term interest rate as the monetary policy instrument," Working Paper Series 2004-22, Federal Reserve Bank of San Francisco.
  11. George W. Evans & Bruce McGough, 2003. "Monetary Policy, Indeterminacy and Learning," University of Oregon Economics Department Working Papers 2003-34, University of Oregon Economics Department, revised 01 Apr 2004.
  12. James Bullard & Kaushik Mitra, 2003. "Determinacy, learnability, and monetary policy inertia," Working Papers 2000-030, Federal Reserve Bank of St. Louis.
  13. John Duffy & Wei Xiao, 2007. "Investment and Monetary Policy: Learning and Determinacy of Equilibrium," Working Papers 324, University of Pittsburgh, Department of Economics, revised Aug 2008.
  14. Preston, Bruce, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," MPRA Paper 830, University Library of Munich, Germany.
  15. Binder,M. & Pesaran,H.M., 1995. "Multivariate Rational Expectations Models and Macroeconomic Modelling: A Review and Some New Results," Cambridge Working Papers in Economics 9415, Faculty of Economics, University of Cambridge.
  16. William A. Branch, 2004. "The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations," Economic Journal, Royal Economic Society, vol. 114(497), pages 592-621, 07.
  17. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
  18. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  19. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, May.
  20. Branch, William A. & McGough, Bruce, 2009. "A New Keynesian model with heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 33(5), pages 1036-1051, May.
  21. Evans, George W. & McGough, Bruce, 2005. "Monetary policy and stable indeterminacy with inertia," Economics Letters, Elsevier, vol. 87(1), pages 1-7, April.
  22. Klein, Paul, 2000. "Using the generalized Schur form to solve a multivariate linear rational expectations model," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1405-1423, September.
  23. 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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