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Monetary policy, indeterminacy and learning

  • Evans, George W.
  • McGough, Bruce

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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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 29 (2005)
Issue (Month): 11 (November)
Pages: 1809-1840

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Handle: RePEc:eee:dyncon:v:29:y:2005:i:11:p:1809-1840
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
  2. Woodford, Michael, 1986. "Learning to Believe in Sunspots," Working Papers 86-16, C.V. Starr Center for Applied Economics, New York University.
  3. Ben S. Bernanke & Michael Woodford, 1997. "Inflation forecasts and monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 653-686.
  4. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
  5. Honkapohja, Seppo & Mitra, Kaushik, 2002. "Performance of monetary policy with internal central bank forecasting," Working Paper Series 0127, European Central Bank.
  6. George W. Evans & Seppo Honkapohja, 2002. "Adaptive Learning and Monetary Policy Design," University of Oregon Economics Department Working Papers 2002-18, University of Oregon Economics Department, revised 04 Mar 2004.
  7. Seppo Honkapohja & Kaushik Mitra, . "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," Discussion Papers 01/05, Department of Economics, University of York.
  8. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  9. 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.
  10. 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.
  11. Howitt, P. & Mcfee, R.P., 1990. "Animal Spirits," UWO Department of Economics Working Papers 9005, University of Western Ontario, Department of Economics.
  12. Bennett T. McCallum & Edward Nelson, 1998. "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," NBER Working Papers 6599, National Bureau of Economic Research, Inc.
  13. 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.
  14. Evans, George W. & Honkapohja, Seppo, 2001. "Expectations and the Stability Problem for Optimal Monetary Policies," CEPR Discussion Papers 2805, C.E.P.R. Discussion Papers.
  15. Paul Romer & George Evans & Seppo Hokapohja, . "Growth Cycles," Home Pages _001, Stanford University.
  16. 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.
  17. Jeff Fuhrer & George Moore, 1995. "Inflation Persistence," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 127-159.
  18. 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.
  19. James B. Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  20. 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.
  21. 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.
  22. 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.
  23. 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.
  24. 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).
  25. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
  26. 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.
  27. 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.
  28. 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.
  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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