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Learning about monetary policy rules when the cost-channel matters

  • Llosa, Luis-Gonzalo
  • Tuesta, Vicente

We study how monetary policy may affect determinacy and expectational stability (E-stability) of rational expectations equilibrium when the cost channel of monetary policy matters. Focusing on instrumental Taylor-type rules and optimal target rules, we show that standard policies can induce indeterminacy and expectational instability when the cost channel is present. A naïve application of the traditional Taylor principle could be misleading, and expectations-based reaction function under discretion does not always induce determinate and E-stable equilibrium. This result contrasts with the findings of Bullard and Mitra [2002. Learning about monetary policy rules. Journal of Monetary Economics 49, 1105-1129] and Evans and Honkapohja [2003. Expectations and stability problem for optimal monetary policies. Review of Economic Studies 70, 807-824] for the standard new Keynesian model. The ability of the central bank to commit to an optimal policy is an antidote to these problems.

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

Volume (Year): 33 (2009)
Issue (Month): 11 (November)
Pages: 1880-1896

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Handle: RePEc:eee:dyncon:v:33:y:2009:i:11:p:1880-1896
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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  1. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1999. "Monetary Policy and Multiple Equilibria," Departmental Working Papers 199914, Rutgers University, Department of Economics.
  2. Honkapohja, Seppo & Evans, George W., 2000. "Expectations and the stability problem for optimal monetary policies," Discussion Paper Series 1: Economic Studies 2000,10, Deutsche Bundesbank, Research Centre.
  3. Kaushik Mitra & James Bullard, 2004. "Determinacy, Learnability, and Monetary Policy Inertia," Royal Holloway, University of London: Discussion Papers in Economics 04/14, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  4. Surico, Paolo, 2008. "The Cost Channel Of Monetary Policy And Indeterminacy," Macroeconomic Dynamics, Cambridge University Press, vol. 12(05), pages 724-735, November.
  5. John Duffy & Wei Xiao, 2007. "The Value of Interest Rate Stabilization Policies When Agents Are Learning," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(8), pages 2041-2056, December.
  6. Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
  7. Chowdhury, Ibrahim & Hoffmann, Mathias & Schabert, Andreas, 2004. "Inflation dynamics and the cost channel of monetary transmission," CFR Working Papers 04-01, University of Cologne, Centre for Financial Research (CFR).
  8. Barth, Marvin J III & Ramey, Valerie A, 2000. "The Cost Channel of Monetary Transmissions," University of California at San Diego, Economics Working Paper Series qt7rm5q9sk, Department of Economics, UC San Diego.
  9. Bennett T. McCallum & Edward Nelson, . "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," GSIA Working Papers 1998-22, Carnegie Mellon University, Tepper School of Business.
  10. Takushi Kurozumi, 2006. "Determinacy and Expectational Stability of Equilibrium in a Monetary Sticky-Price Model with Taylor Rule," Bank of Japan Working Paper Series 06-E-2, Bank of Japan.
  11. 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.
  12. James B. Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  13. Bruce Preston, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
  14. 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.
  15. Bruckner, Matthias & Schabert, Andreas, 2003. "Supply-side effects of monetary policy and equilibrium multiplicity," Economics Letters, Elsevier, vol. 79(2), pages 205-211, May.
  16. Bennett T. McCallum, 1981. "On Non-Uniqueness in Rational Expectations Models: An Attempt at Perspective," NBER Working Papers 0684, National Bureau of Economic Research, Inc.
  17. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers 2002-11, University of Oregon Economics Department, revised 01 Feb 2004.
  18. 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.
  19. 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.
  20. McCallum, Bennett T., 2007. "E-stability vis-a-vis determinacy results for a broad class of linear rational expectations models," Journal of Economic Dynamics and Control, Elsevier, vol. 31(4), pages 1376-1391, April.
  21. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  22. James B. Bullard, 2006. "The learnability criterion and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 203-217.
  23. Marc Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
  24. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier.
  25. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
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