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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. Evans, Geroge W & Honkapohja, Seppo & Romer, Paul, 1998. "Growth Cycles," American Economic Review, American Economic Association, vol. 88(3), pages 495-515, June.
  2. Evans, George W. & McGough, Bruce, 2005. "Stable sunspot solutions in models with predetermined variables," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 601-625, April.
  3. George W. Evans & Seppo Honkapohja, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," University of Oregon Economics Department Working Papers 2001-6, University of Oregon Economics Department, revised 03 Aug 2001.
  4. Fuhrer, Jeff & Moore, George, 1995. "Inflation Persistence," The Quarterly Journal of Economics, MIT Press, vol. 110(1), pages 127-59, February.
  5. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  6. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  7. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  8. George W. Evans & Seppo Honkapohja & Ramon Marimon, 2001. "Stable Sunspot Equilibria in a Cash-in-Advance Economy," CESifo Working Paper Series 611, CESifo Group Munich.
  9. Evans, George W & Honkapohja, Seppo, 2003. "Adaptive Learning and Monetary Policy Design," CEPR Discussion Papers 3962, C.E.P.R. Discussion Papers.
  10. Woodford, Michael, 1990. "Learning to Believe in Sunspots," Econometrica, Econometric Society, vol. 58(2), pages 277-307, March.
  11. Honkapohja, Seppo & Mitra, Kaushik, 2005. "Performance of monetary policy with internal central bank forecasting," Journal of Economic Dynamics and Control, Elsevier, vol. 29(4), pages 627-658, April.
  12. Howitt, Peter, 1992. "Interest Rate Control and Nonconvergence to Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 776-800, August.
  13. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  14. Farmer Roger E. A. & Guo Jang-Ting, 1994. "Real Business Cycles and the Animal Spirits Hypothesis," Journal of Economic Theory, Elsevier, vol. 63(1), pages 42-72, June.
  15. Evans, G. E. & Guesnerie R., 1999. "Coordination on saddle path solutions : the eductive viewpoint. 1 - linear univariate models," DELTA Working Papers 1999-15, DELTA (Ecole normale supérieure).
  16. Evans George W & McGough Bruce, 2005. "Indeterminacy and the Stability Puzzle in Non-Convex Economies," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-46, September.
  17. Seppo Honkapohja & Kaushik Mitra, . "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," Discussion Papers 01/05, Department of Economics, University of York.
  18. 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 2001-9, University of Oregon Economics Department, revised 14 Jan 2002.
  19. 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.
  20. Woodford, Michael, 1999. "Optimal monetary policy inertia," CFS Working Paper Series 1999/09, Center for Financial Studies (CFS).
  21. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  22. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
  23. Howitt, P. & Mcfee, R.P., 1990. "Animal Spirits," UWO Department of Economics Working Papers 9005, University of Western Ontario, Department of Economics.
  24. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
  25. Evans George W. & Honkapohja Seppo, 1994. "On the Local Stability of Sunspot Equilibria under Adaptive Learning Rules," Journal of Economic Theory, Elsevier, vol. 64(1), pages 142-161, October.
  26. G. Desgranges & G. Negroni, 2001. "Expectations Coordination on a Sunspot Equilibrium: an Eductive Approach," THEMA Working Papers 2001-13, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  27. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  28. Evans, George W. & Honkapohja, Seppo, 2003. "Existence of adaptively stable sunspot equilibria near an indeterminate steady state," Journal of Economic Theory, Elsevier, vol. 111(1), pages 125-134, July.
  29. 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, vol. 21(7), pages 1149-1171, June.
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