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Indeterminacy with inflation-forecast-based rules in a two-bloc model

  • Nicoletta Batini
  • Paul Levine
  • Joseph Pearlman

We examine the performance of forward-looking inflation-forecast-based rules in open economies. In a New Keynesian two-bloc model, a methodology first employed by Batini and Pearlman (2002) is used to obtain analytically the feedback parameters/horizon pairs associated with unique and stable equilibria. Three key findings emerge: First, indeterminacy occurs for any value of the feedback parameter on inflation if the forecast horizon lies too far into the future. Second, the problem of indeterminacy is intrinsically more serious in the open economy. Third, the problem is compounded further in the open economy when central banks respond to expected consumer, rather than producer price inflation.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 797.

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Date of creation: 2004
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Handle: RePEc:fip:fedgif:797
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  1. V.V. Chari & Lawrence J. Christiano & Martin Eichenbaum, 1996. "Expectation traps and discretion," Working Paper Series, Macroeconomic Issues WP-96-5, Federal Reserve Bank of Chicago.
  2. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  3. Nicoletta Batini & Richard Harrison & Stephen P. Millard, 2001. "Monetary policy rules for an open economy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  4. Batini, Nicoletta & Nelson, Edward, 2000. "Optimal Horizons for Inflation Targeting," Working Paper Series 103, Sveriges Riksbank (Central Bank of Sweden).
  5. Nicoletta Batini & Andrew Haldane, 1999. "Forward-Looking Rules for Monetary Policy," NBER Chapters, in: Monetary Policy Rules, pages 157-202 National Bureau of Economic Research, Inc.
  6. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers 1908, C.E.P.R. Discussion Papers.
  7. Efrem Castelnuovo, 2003. "Taylor Rules and Interest Rate Smoothing in the US and EMU," Macroeconomics 0303002, EconWPA.
  8. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1998. "Monetary policy and multiple equilibria," Finance and Economics Discussion Series 1998-29, Board of Governors of the Federal Reserve System (U.S.).
  9. De Fiore, Fiorella & Liu, Zheng, 2002. "Openness and equilibrium determinacy under interest rate rules," Working Paper Series 0173, European Central Bank.
  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. Nicoletta Batini & Joseph Pearlman, 2002. "Too Much Too Soon: Instability and Indeterminacy with Forward-Looking Rules," Discussion Papers 08, Monetary Policy Committee Unit, Bank of England.
  12. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  13. Devereux, Michael B. & Yetman, James, 2002. "Menu costs and the long-run output-inflation trade-off," Economics Letters, Elsevier, vol. 76(1), pages 95-100, June.
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  17. repec:cup:cbooks:9780521104609 is not listed on IDEAS
  18. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Real Indeterminacy in Monetary Models with Nominal Interest Rate Distortions," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 767-789, October.
  19. repec:cup:cbooks:9780521441964 is not listed on IDEAS
  20. Charles T. Carlstrom & Timothy S. Fuerst, 2000. "Forward-looking versus backward-looking Taylor rules," Working Paper 0009, Federal Reserve Bank of Cleveland.
  21. Benigno, Gianluca & Benigno, Pierpaolo, 2002. "Implementing Monetary Cooperation Through Inflation Targeting," CEPR Discussion Papers 3226, C.E.P.R. Discussion Papers.
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