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Chaotic Interest Rate Rules

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Author Info
Jess Benhabib () (New York University)
Stephanie Schmitt-Grohe () (Rutgers University)
Martin Uribe () (University of Pennsylvania)

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Abstract

A growing empirical and theoretical literature argues in favor of specifying monetary policy in the form of Taylor-type interest rate feedback rules. That is, rules whereby the nominal interest rate is set as an increasing function of inflation with a slope greater than one around an intended inflation target. This paper shows that such rules can easily lead to chaotic dynamics. The result is obtained for feedback rules that depend on contemporaneous or expected future inflation. The existence of chaotic dynamics is established analytically and numerically in the context of calibrated economies. The battery of fiscal policies that have recently been advocated for avoiding global indeterminacy induced by Taylor-type interest-rate rules (such as liquidity traps) are shown to be unlikely to provide a remedy for the complex dynamics characterized in this paper.

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Paper provided by Rutgers University, Department of Economics in its series Departmental Working Papers with number 200109.

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Date of creation: 18 Oct 2001
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Handle: RePEc:rut:rutres:200109

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Related research
Keywords: chaos; periodic equilibria; Taylor rules ;

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

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  4. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April. [Downloadable!] (restricted)
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  5. Lawrence J. Christiano & Massimo Rostagno, 2001. "Money Growth Monitoring and the Taylor Rule," NBER Working Papers 8539, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  10. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Avoiding Liquidity Traps," CEPR Discussion Papers 2948, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  19. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "The Perils of Taylor Rules," Journal of Economic Theory, Elsevier, vol. 96(1-2), pages 40-69, January. [Downloadable!] (restricted)
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  20. Leeper, Eric M., 1991. "Equilibria under 'active' and 'passive' monetary and fiscal policies," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 129-147, February. [Downloadable!] (restricted)
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  22. 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. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jess Benhabib & Stefano Eusepi, 2005. "The design of monetary and fiscal policy: a global perspective," Proceedings, Federal Reserve Bank of San Francisco. [Downloadable!]
    Other versions:
  2. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Avoiding Liquidity Traps," CEPR Discussion Papers 2948, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  3. Orlando Gomes, 2004. "A Continuous-Time Asset Pricing Model with Boundedly Rational Heterogeneous Agents," Finance 0409055, EconWPA. [Downloadable!]
  4. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2003. "Backward-Looking Interest-Rate Rules, Interest-Rate Smoothing, and Macroeconomic Instability," Departmental Working Papers 200304, Rutgers University, Department of Economics. [Downloadable!]
    Other versions:
  5. Lawrence Christiano & Roberto Motto & Massimo Rostagno, 2007. "Two Reasons Why Money and Credit May be Useful in Monetary Policy," NBER Working Papers 13502, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Orlando Gomes, . "Volatility, Heterogeneous Agents and Chaos," The Electronic Journal of Evolutionary Modeling and Economic Dynamics, IFReDE - Université Montesquieu Bordeaux IV. [Downloadable!]
    Other versions:
  7. Stefano Eusepi, 2005. "Comparing forecast-based and backward-looking Taylor rules: a "global" analysis," Staff Reports 198, Federal Reserve Bank of New York. [Downloadable!]
  8. Marco Airaudo & Luis-Felipe Zanna, 2005. "Interest rate rules, endogenous cycles, and chaotic dynamics in open economies," International Finance Discussion Papers 849, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  9. Marco Airaudo & Luis-Felipe Zanna, 2004. "Endogenous Fluctuations in Open Economies: the Perils of Taylor Rules Revisited," Econometric Society 2004 Latin American Meetings 80, Econometric Society. [Downloadable!]
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  10. Buiter, Willem H & Sibert, Anne, 2006. "Deflationary Bubbles," CEPR Discussion Papers 5637, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  11. Orlando Gomes, 2004. "Optimal Monetary Policy under Heterogeneous Expectations," Macroeconomics 0409023, EconWPA. [Downloadable!]
  12. Stefano Eusepi, 2005. "Central bank transparency under model uncertainty," Staff Reports 199, Federal Reserve Bank of New York. [Downloadable!]
  13. Vivaldo M. Mendes & Diana A. Mendes, 2006. "Active Interest Rate Rules and the Role of Stabilization Policy R&D Tax Credits," Working Papers ercwp0208, ISCTE, UNIDE, Economics Research Centre. [Downloadable!]
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