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Monetary policy, indeterminacy and learning

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  • Evans, George W.
  • McGough, Bruce

Abstract

The development of tractable forward looking models of monetary policy has lead to an explosion of research on the implications of adopting Taylor-type interest rate rules. Indeterminacies have been found to arise for some specifications of the interest rate rule, raising the possibility of inefficient fluctuations due to the dependence of expectations on extraneous “sunspots ”. Separately, recent work by a number of authors has shown that sunspot equilibria previously thought to be unstable under private agent learning can in some cases be stable when the observed sunspot has a suitable time series structure. In this paper we generalize the “common factor ”technique, used in this analysis, to examine standard monetary models that combine forward looking expectations and predetermined variables. We consider a variety of specifications that incorporate both lagged and expected inflation in the Phillips Curve, and both expected inflation and inertial elements in the policy rule. We find that some policy rules can indeed lead to learnable sunspot solutions and we investigate the conditions under which this phenomenon arises. --

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Bibliographic Info

Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2003/37.

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Date of creation: 2003
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Handle: RePEc:zbw:cfswop:200337

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Keywords: Monetary Policy; sunspots; expectations; learning; stability;

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  1. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(6), pages 1161-1187, September.
  2. Honkapohja, S. & Mitra, K., 2001. "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," University of Helsinki, Department of Economics, Department of Economics 501, Department of Economics.
  3. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Research Discussion Papers, Bank of Finland 3/2002, Bank of Finland.
  4. George Evans & Seppo Honkapohja & Paul Romer, 1996. "Growth Cycles," NBER Working Papers 5659, National Bureau of Economic Research, Inc.
  5. Woodford, Michael, 1990. "Learning to Believe in Sunspots," Econometrica, Econometric Society, Econometric Society, vol. 58(2), pages 277-307, March.
  6. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 29(4), pages 653-84, November.
  7. Jeff Fuhrer & George Moore, 1993. "Inflation persistence," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  8. Desgranges, Gabriel & Negroni, Giorgio, 2003. "Expectations Coordination On A Sunspot Equilibrium: An Eductive Approach," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 7(01), pages 7-41, February.
  9. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  10. Garratt, Anthony & Hall, Stephen G., 1997. "E-equilibria and adaptive expectations: Output and inflation in the LBS model," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 21(7), pages 1149-1171, June.
  11. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, Elsevier, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  12. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 39(1), pages 195-214, December.
  13. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers, Federal Reserve Bank of St. Louis 2000-001, Federal Reserve Bank of St. Louis.
  14. George W. Evans & Seppo Honkapohja, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2001-6, University of Oregon Economics Department, revised 03 Aug 2001.
  15. Evans, George W. & Honkapohja, Seppo, 2002. "Adaptive learning and monetary policy design," Research Discussion Papers, Bank of Finland 29/2002, Bank of Finland.
  16. Julio J. Rotemberg & Michael Woodford, 1998. "Interest-Rate Rules in an Estimated Sticky Price Model," NBER Working Papers 6618, National Bureau of Economic Research, Inc.
  17. George W. Evans & Bruce McGough, 2002. "Stable Sunspot Solutions in Models with Predetermined Variables," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2002-16, University of Oregon Economics Department, revised 29 May 2003.
  18. Evans, George W. & Guesnerie, Roger, 2003. "Coordination On Saddle-Path Solutions: The Eductive Viewpoint Linear Univariate Models," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 7(01), pages 42-62, February.
  19. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," NBER Working Papers 6442, National Bureau of Economic Research, Inc.
  20. Evans, George W. & Honkapohja, Seppo, 2003. "Existence of adaptively stable sunspot equilibria near an indeterminate steady state," Journal of Economic Theory, Elsevier, Elsevier, vol. 111(1), pages 125-134, July.
  21. George W. Evans & Bruce McGough, 2002. "Indeterminacy and the Stability Puzzle in Non-Convex Economies," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2002-14, University of Oregon Economics Department, revised 27 Aug 2005.
  22. Howitt, Peter, 1992. "Interest Rate Control and Nonconvergence to Rational Expectations," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(4), pages 776-800, August.
  23. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  24. Howitt, Peter & McAfee, R Preston, 1992. "Animal Spirits," American Economic Review, American Economic Association, American Economic Association, vol. 82(3), pages 493-507, June.
  25. George W. Evans & Seppo Honkapohja & Ramon Marimon, 2003. "Stable Sunspot Equilibria in a Cash-in-Advance Economy," Working Papers 14, Barcelona Graduate School of Economics.
  26. Roger E.A. Farmer & Jang Ting Guo, 1992. "Real Business Cycles and the Animal Spirits Hypothesis," UCLA Economics Working Papers, UCLA Department of Economics 680, UCLA Department of Economics.
  27. George W. Evans & Seppo Honkapohja, 2002. "Expectational Stability of Stationary Sunspot Equilibria in a Forward-looking Linear Model," University of Oregon Economics Department Working Papers, University of Oregon Economics Department 2001-9, University of Oregon Economics Department, revised 14 Jan 2002.
  28. Evans George W. & Honkapohja Seppo, 1994. "On the Local Stability of Sunspot Equilibria under Adaptive Learning Rules," Journal of Economic Theory, Elsevier, Elsevier, vol. 64(1), pages 142-161, October.
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