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Comparing forecast-based and backward-looking Taylor rules: a "global" analysis

  • Stefano Eusepi

This paper examines the performance of forecast-based nonlinear Taylor rules in a class of simple microfunded models. The paper shows that even if the policy rule leads to a locally determinate (and stable) inflation target, there exist other learnable "global" equilibria such as cycles and sunspots. Moreover, under learning dynamics, the economy can fall into a liquidity trap. By contrast, more backward-looking and "active" Taylor rules guarantee that the unique learnable equilibrium is the inflation target. This result is robust to different specifications of the role of money, price stickiness, and the trading environment.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 198.

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Date of creation: 2005
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Handle: RePEc:fip:fednsr:198
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  1. Lawrence J. Christiano & Massimo Rostagno, 2001. "Money Growth Monitoring and the Taylor Rule," NBER Working Papers 8539, National Bureau of Economic Research, Inc.
  2. Seppo Honkapohja & Kaushik Mitra, . "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," Discussion Papers 01/05, Department of Economics, University of York.
  3. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Timing and real indeterminacy in monetary models," Working Paper 9910R, Federal Reserve Bank of Cleveland.
  4. George W. Evans & Seppo Honkapohja, 2002. "Existence of Adaptively Stable Sunspot Equilibria near an Indeterminate Steady State," University of Oregon Economics Department Working Papers 2002-9, University of Oregon Economics Department, revised 06 Apr 2002.
  5. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  6. Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc.
  7. Evans George W & Honkapohja Seppo M.S. & Marimon Ramon, 2007. "Stable Sunspot Equilibria in a Cash-in-Advance Economy," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-38, January.
  8. Stephanie Schmitt-Grohe & Jess Benhabib & Martin Uribe, 2001. "Monetary Policy and Multiple Equilibria," American Economic Review, American Economic Association, vol. 91(1), pages 167-186, March.
  9. Andrew Levin & Volker Wieland & John Williams, 2000. "The Performance Of Forecast-Based Monetary Policy Rules Under Model Uncertainty," Computing in Economics and Finance 2000 203, Society for Computational Economics.
  10. Batini, Nicoletta & Nelson, Edward, 2000. "Optimal Horizons for Inflation Targeting," Working Paper Series 103, Sveriges Riksbank (Central Bank of Sweden).
  11. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Learning and the central bank," Working Paper 0117, Federal Reserve Bank of Cleveland.
  12. Grandmont, Jean-Michel & Pintus, Patrick & de Vilder, Robin, 1998. "Capital-Labor Substitution and Competitive Nonlinear Endogenous Business Cycles," Journal of Economic Theory, Elsevier, vol. 80(1), pages 14-59, May.
  13. Grandmont, Jean-Michel, 1986. "Stabilizing competitive business cycles," Journal of Economic Theory, Elsevier, vol. 40(1), pages 57-76, October.
  14. GRANDMONT, Jean-Michel, 1997. "Expectations formation and stability of large socioeconomic systems," CORE Discussion Papers 1997088, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  15. James Bullard & John Duffy, 1995. "On learning and the stability of cycles," Working Papers 1995-006, Federal Reserve Bank of St. Louis.
  16. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 2000. "Avoiding Liquidity Traps," Departmental Working Papers 199925, Rutgers University, Department of Economics.
  17. Bullard, James & Duffy, John, 1998. "Learning And The Stability Of Cycles," Macroeconomic Dynamics, Cambridge University Press, vol. 2(01), pages 22-48, March.
  18. Michael Woodford, 2000. "Pitfalls of Forward-Looking Monetary Policy," American Economic Review, American Economic Association, vol. 90(2), pages 100-104, May.
  19. Bernanke, Ben S & Woodford, Michael, 1997. "Inflation Forecasts and Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 653-84, November.
  20. Benhabib, Jess & Schmitt-Grohe, Stephanie & Uribe, Martin, 2001. "Chaotic Interest Rate Rules," Computing in Economics and Finance 2001 259, Society for Computational Economics.
  21. Charles T. Carlstrom & Timothy S. Fuerst, 2000. "Forward-looking versus backward-looking Taylor rules," Working Paper 0009, Federal Reserve Bank of Cleveland.
  22. Lawrence J. Christiano & Sharon G. Harrison, 1996. "Chaos, Sunspots, and Automatic Stabilizers," NBER Working Papers 5703, National Bureau of Economic Research, Inc.
  23. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  24. repec:cup:macdyn:v:2:y:1998:i:1:p:22-48 is not listed on IDEAS
  25. Azariadis, Costas & Guesnerie, Roger, 1986. "Sunspots and Cycles," Review of Economic Studies, Wiley Blackwell, vol. 53(5), pages 725-37, October.
  26. Bloise, Gaetano, 2001. "A Geometric Approach to Sunspot Equilibria," Journal of Economic Theory, Elsevier, vol. 101(2), pages 519-539, December.
  27. Evans, George W & Honkapohja, Seppo, 1995. "Local Convergence of Recursive Learning to Steady States and Cycles in Stochastic Nonlinear Models," Econometrica, Econometric Society, vol. 63(1), pages 195-206, January.
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