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Investment and Monetary Policy: Learning and Determinacy of Equilibrium

  • JOHN DUFFY
  • WEI XIAO

We examine determinancy and expectational stability (learnability) of rational expectations equilibrium (REE) in sticky price New Keynesian (NK) models of the monetary transmission mechanism. We consider three different New Keynesian models: a labor-only model and two models that add capital -- one where capital is allocated in an economy-wide rental market and another where demand for capital is firm-specific. We find that Bullard and Mitra's (2002, 2007) findings on determinacy and learnability of REE under various interest rate rules in the labor-only NK model do not always extend to models with capital. In particular, the Taylor principle, that the response of interest rates should be more than proportionate to changes in inflation, will not generally suffice to guarantee determinate and/or learnable equilibria in NK models with capital.

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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 43 (2011)
Issue (Month): 5 (08)
Pages: 959-992

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Handle: RePEc:mcb:jmoncb:v:43:y:2011:i:5:p:959-992
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Sveen, Tommy & Weinke, Lutz, 2005. "New perspectives on capital, sticky prices, and the Taylor principle," Journal of Economic Theory, Elsevier, vol. 123(1), pages 21-39, July.
  2. Woodford, Michael, 2005. "Firm-Specific Capital and the New Keynesian Phillips Curve," MPRA Paper 825, University Library of Munich, Germany.
  3. 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.
  4. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  5. Bill Dupor, 2000. "Investment and Interest Rate Policy," Econometric Society World Congress 2000 Contributed Papers 0007, Econometric Society.
  6. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  7. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  8. Sveen, Tommy & Weinke, Lutz, 2007. "Firm-specific capital, nominal rigidities, and the Taylor principle," Journal of Economic Theory, Elsevier, vol. 136(1), pages 729-737, September.
  9. Marc Paolo Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
  10. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 861-886, October.
  11. 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.
  12. Kurozumi, Takushi & Van Zandweghe, Willem, 2008. "Investment, interest rate policy, and equilibrium stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1489-1516, May.
  13. 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.
  14. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  15. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64.
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