Determinacy in New Keynesian models: a role for money after all?
The New-Keynesian Taylor-Rule model of inflation determination with no role for money is incomplete. As Cochrane (2007a) argues, it has no credible mechanism for ruling out bubbles and as a results fails to provide a reason for private agents to pick a unique stable path. We propose a way forward. Our proposal is in effect that the New-Keynesian model should be formulated with a money demand and money supply function. It should also embody a terminal condition for money supply behaviour. If an unstable path occurred the central bank would switch to a money supply Rule explicitly designed to stop it via the terminal condition. This would be therefore a 'threat/trigger strategy' complementing the Taylor Rule - only to be invoked if inflation misbehaved. Thus we answer the criticisms levelled at the Taylor Rule that it has no credible mechanism for ruling out bubbles. However it does imply that money cannot be avoided int he New Keynesian set-up, contrary to Woodford (2008).
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| Length: | 25 pages |
| Date of creation: | Oct 2009 |
| Date of revision: | Apr 2011 |
| Handle: | RePEc:cdf:wpaper:2009/21 |
| Contact details of provider: | Postal: Phone: +44 (0) 29 20874417 Fax: +44 (0) 29 20874419 Web page: http://business.cardiff.ac.uk/research/academic-sections/economics/working-papers More information through EDIRC
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