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Nominal Interest Rate Rules under Heterogeneous Beliefs

  • Hehui JIN

    (Quantify Solutions, NJ, USA)

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    This paper presents simple models with competitive markets, fully flexible prices and fully observable macro-economic variables. Agents hold heterogeneous beliefs because the exogenous shocks are stable but non-stationary and the true law of motion is unknown to agents. We show that the diversity of beliefs enables monetary policy to have real effects and the fluctuations in beliefs cause excess volatilities in real economy. By log-linearization we derive a version of the aggregate supply curve which relates aggregate employment to the discrepancies between the market forecast of inflation rate and the stationary forecast of it. The computational results demonstrate that monetary policy rules can dramatically reduce consumption volatility and there is a tradeoff between stability of consumption and inflation. The results are thus comparable with Kurz - Jin - Motolese (2003).

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    Article provided by Vita e Pensiero, Pubblicazioni dell'Universita' Cattolica del Sacro Cuore in its journal Rivista Internazionale di Scienze Sociali.

    Volume (Year): 115 (2007)
    Issue (Month): 3 ()
    Pages: 403-442

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    Handle: RePEc:vep:journl:y:2007:v:115:i:3:p:403-442
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    1. Hyun Song Shin & Jeffery D. Amato, 2003. "Public and private information in monetary policy models," BIS Working Papers 138, Bank for International Settlements.
    2. Stephen Morris & Franklin Allen & Hyun Song Shin, 2004. "Beauty Contests, Bubbles and Iterated Expectations in Asset Markets," Yale School of Management Working Papers ysm346, Yale School of Management.
    3. Maurizio Motolese, 2003. "Endogenous uncertainty and the non-neutrality of money," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 21(2), pages 317-345, 03.
    4. Bennett T. McCallum & Edward Nelson, 1998. "Performance of operational policy rules in an estimated semi-classical structural model," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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    6. Frederic S. Mishkin, 1980. "Does Anticipated Monetary Policy Matter? An Econometric Investigation," NBER Working Papers 0506, National Bureau of Economic Research, Inc.
    7. Kurz, Mordecai, 1994. "On the Structure and Diversity of Rational Beliefs," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 4(6), pages 877-900, October.
    8. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
    9. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information versus Sticky Prices: A Proposal to Replace the New Keynesian Phillips Curve," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1295-1328.
    10. Maurizio Motolese, 2001. "Money non-neutrality in a Rational Belief Equilibrium with financial assets," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 18(1), pages 97-126.
    11. Kurz, Mordecai & Jin, Hehui & Motolese, Maurizio, 2005. "The role of expectations in economic fluctuations and the efficacy of monetary policy," Journal of Economic Dynamics and Control, Elsevier, vol. 29(11), pages 2017-2065, November.
    12. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
    13. Radner, Roy, 1972. "Existence of Equilibrium of Plans, Prices, and Price Expectations in a Sequence of Markets," Econometrica, Econometric Society, vol. 40(2), pages 289-303, March.
    14. Christian Hellwig, 2002. "Public Announcements, Adjustment Delays, and the Business Cycle (November 2002)," UCLA Economics Online Papers 208, UCLA Department of Economics.
    15. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
    16. Jess Gaspar & Kenneth L. Judd, 1997. "Solving Large Scale Rational Expectations Models," NBER Technical Working Papers 0207, National Bureau of Economic Research, Inc.
    17. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    18. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    19. 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.
    20. Batchelor, Roy & Dua, Pami, 1991. "Blue Chip Rationality Tests," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(4), pages 692-705, November.
    21. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
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