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Determinacy in New Keynesian Models: a role for money after all?

  • Minford, Patrick
  • Srinivasan, Naveen

The New-Keynesian Taylor-Rule model of inflation determination with no role for money is incomplete. As Cochrane (2007a, b) argues, it has no credible mechanism for ruling out bubbles (or deal with the non-uniqueness problem that arises when the Taylor principle is violated) and as a result 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 indeterminacy of stable (or unstable paths) 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 dealing with these issues. However it does imply that money cannot be avoided in the new Keynesian set-up, contrary to Woodford (2008).

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7960.

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Date of creation: Aug 2010
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Handle: RePEc:cpr:ceprdp:7960
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  1. Maurice Obstfeld & Kenneth S. Rogoff, 1981. "Speculative hyperinflations in a maximizing models: can we rule them out?," International Finance Discussion Papers 195, Board of Governors of the Federal Reserve System (U.S.).
  2. John B. Taylor, 2000. "Teaching Modern Macroeconomics at the Principles Level," American Economic Review, American Economic Association, vol. 90(2), pages 90-94, May.
  3. Minford, Patrick, 2008. "Commentary on Economic Projections and Rules of Thumb for Monetary Policy (by Athanasios Orphanides and Volker Wieland)," Cardiff Economics Working Papers E2008/16, Cardiff University, Cardiff Business School, Economics Section.
  4. 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.
  5. Michael Woodford, 2007. "How Important is Money in the Conduct of Monetary Policy?," Levine's Working Paper Archive 122247000000001419, David K. Levine.
  6. repec:oup:qjecon:v:115:y:2000:i:1:p:147-180 is not listed on IDEAS
  7. John H. Cochrane, 2007. "Determinacy and Identification with Taylor Rules," NBER Working Papers 13410, National Bureau of Economic Research, Inc.
  8. Dale W. Henderson & Warwick J. McKibbin, 1993. "A comparison of some basic monetary policy regimes for open economies: implications of different degrees of instrument adjustment and wage persistence," International Finance Discussion Papers 458, Board of Governors of the Federal Reserve System (U.S.).
  9. 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.
  10. 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.
  11. Benjamin Friedman, 2003. "The LM Curve: A Not-So-Fond Farewell," NBER Working Papers 10123, National Bureau of Economic Research, Inc.
  12. Patrick Minford & David Peel, 2003. "Optimal monetary policy: is price-level targeting the next step?," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 650-667, November.
  13. Bennett T. McCallum, 2008. "Inflation Determination with Taylor Rules: Is New Keynesian Analysis Critically Flawed?," NBER Working Papers 14534, National Bureau of Economic Research, Inc.
  14. David H. Romer, 2000. "Keynesian Macroeconomics without the LM Curve," Journal of Economic Perspectives, American Economic Association, vol. 14(2), pages 149-169, Spring.
  15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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