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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. Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies.
  2. Lawrence J. Christiano & Sharon G. Harrison, 1996. "Chaos, sunspots, and automatic stabilizers," Staff Report 214, Federal Reserve Bank of Minneapolis.
  3. George W. Evans & Seppo Honkapohja, 2001. "Existence of Adaptively Stable Sunspot Equilibria Near an Indeterminate Steady State," CESifo Working Paper Series 478, CESifo Group Munich.
  4. Jess Benhabib & Stephanie Schmitt-Grohe & Martin Uribe, 1999. "Monetary Policy and Multiple Equilibria," Departmental Working Papers 199914, Rutgers University, Department of Economics.
  5. 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.
  6. Charles T. Carlstrom & Timothy S. Fuerst, 2000. "Forward-looking versus backward-looking Taylor rules," Working Paper 0009, Federal Reserve Bank of Cleveland.
  7. Andrew Levin & Volker Wieland & John C. Williams, 2003. "The Performance of Forecast-Based Monetary Policy Rules Under Model Uncertainty," American Economic Review, American Economic Association, vol. 93(3), pages 622-645, June.
  8. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Avoiding Liquidity Traps," CEPR Discussion Papers 2948, C.E.P.R. Discussion Papers.
  9. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  10. Charles T. Carlstrom & Timothy S. Fuerst, 2001. "Learning and the central bank," Working Paper 0117, Federal Reserve Bank of Cleveland.
  11. Kaushik Mitra & Seppo Honkapohja, 2004. "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," Royal Holloway, University of London: Discussion Papers in Economics 04/13, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  12. GRANDMONT, Jean-Michel & PINTUS, Patrick & de VILDER, Robin, 1997. "Capital-labor substitution and competitive nonlinear endogenous business cycles," CORE Discussion Papers 1997087, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  13. Jean-Michel Grandmont, 1997. "Expectations Formation and Stability of Large Socioeconomic Systems," Working Papers 97-27, Centre de Recherche en Economie et Statistique.
  14. George W. Evans & Seppo Honkapohja & Ramon Marimon, 2002. "Stable Sunspot Equilibira in a Cash-in-Advance Economy," University of Oregon Economics Department Working Papers 2001-5, University of Oregon Economics Department, revised 15 Nov 2005.
  15. repec:cup:macdyn:v:2:y:1998:i:1:p:22-48 is not listed on IDEAS
  16. Nicoletta Batini & Edward Nelson, 2000. "Optimal horizons for inflation targeting," Bank of England working papers 119, Bank of England.
  17. Carlstrom, Charles T. & Fuerst, Timothy S., 2001. "Timing and real indeterminacy in monetary models," Journal of Monetary Economics, Elsevier, vol. 47(2), pages 285-298, April.
  18. Bloise, Gaetano, 2001. "A Geometric Approach to Sunspot Equilibria," Journal of Economic Theory, Elsevier, vol. 101(2), pages 519-539, December.
  19. Jess Benhabib & Stephanie Schmitt-Groh� & Mart�n Uribe, 2002. "Chaotic Interest-Rate Rules," American Economic Review, American Economic Association, vol. 92(2), pages 72-78, May.
  20. Azariadis, Costas & Guesnerie, Roger, 1986. "Sunspots and Cycles," Review of Economic Studies, Wiley Blackwell, vol. 53(5), pages 725-37, October.
  21. James Bullard & John Duffy, 1995. "On learning and the stability of cycles," Working Papers 1995-006, Federal Reserve Bank of St. Louis.
  22. Lawrence J. Christiano & Massimo Rostagno, 2001. "Money Growth Monitoring and the Taylor Rule," NBER Working Papers 8539, National Bureau of Economic Research, Inc.
  23. Grandmont Jean-michel, 1985. "Stabilizing competitive business cycles," CEPREMAP Working Papers (Couverture Orange) 8518, CEPREMAP.
  24. Ben S. Bernanke & Michael Woodford, 1997. "Inflation forecasts and monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 653-686.
  25. Michael Woodford, 2000. "Pitfalls of Forward-Looking Monetary Policy," American Economic Review, American Economic Association, vol. 90(2), pages 100-104, May.
  26. Bullard, James & Duffy, John, 1998. "Learning And The Stability Of Cycles," Macroeconomic Dynamics, Cambridge University Press, vol. 2(01), pages 22-48, March.
  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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