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Chaotic dynamics in optimal monetary policy

Author

Listed:
  • O. Gomes
  • V. M. Mendes
  • D. A. Mendes
  • J. Sousa Ramos

Abstract

There is by now a large consensus in modern monetary policy. This consensus has been built upon a dynamic general equilibrium model of optimal monetary policy as developed by, e.g., Goodfriend and King [NBER Macroeconomics Annual 1997 edited by B. Bernanke and J. Rotemberg (Cambridge, Mass.: MIT Press, 1997), pp. 231–282], Clarida et al. [J. Econ. Lit. 37, 1661 (1999)], Svensson [J. Mon. Econ. 43, 607 (1999)] and Woodford [Interest and Prices: Foundations of a Theory of Monetary Policy (Princeton, New Jersey, Princeton University Press, 2003)]. In this paper we extend the standard optimal monetary policy model by introducing nonlinearity into the Phillips curve. Under the specific form of nonlinearity proposed in our paper (which allows for convexity and concavity and secures closed form solutions), we show that the introduction of a nonlinear Phillips curve into the structure of the standard model in a discrete time and deterministic framework produces radical changes to the major conclusions regarding stability and the efficiency of monetary policy. We emphasize the following main results: (i) instead of a unique fixed point we end up with multiple equilibria; (ii) instead of saddle-path stability, for different sets of parameter values we may have saddle stability, totally unstable equilibria and chaotic attractors; (iii) for certain degrees of convexity and/or concavity of the Phillips curve, where endogenous fluctuations arise, one is able to encounter various results that seem intuitively correct. Firstly, when the Central Bank pays attention essentially to inflation targeting, the inflation rate has a lower mean and is less volatile; secondly, when the degree of price stickiness is high, the inflation rate displays a larger mean and higher volatility (but this is sensitive to the values given to the parameters of the model); and thirdly, the higher the target value of the output gap chosen by the Central Bank, the higher is the inflation rate and its volatility. Copyright EDP Sciences/Società Italiana di Fisica/Springer-Verlag 2007

Suggested Citation

  • O. Gomes & V. M. Mendes & D. A. Mendes & J. Sousa Ramos, 2007. "Chaotic dynamics in optimal monetary policy," The European Physical Journal B: Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 57(2), pages 195-199, May.
    • Handle: RePEc:spr:eurphb:v:57:y:2007:i:2:p:195-199
    DOI: 10.1140/epjb/e2007-00123-6
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    References listed on IDEAS

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    1. Nobay, A. R. & Peel, D. A., 2000. "Optimal monetary policy with a nonlinear Phillips curve," Economics Letters, Elsevier, vol. 67(2), pages 159-164, May.
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