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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. 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.
  2. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 2001. "Avoiding Liquidity Traps," CEPR Discussion Papers 2948, C.E.P.R. Discussion Papers.
  3. Benhabib, J. & Schmitt-Grohe, S. & Uribe, M., 1998. "Monetary Policy and Multiple Equilibria," Working Papers 98-02, C.V. Starr Center for Applied Economics, New York University.
  4. George W. Evans & Seppo Honkapohja & Ramon Marimon, 2004. "Stable sunspot equilibria in a cash-in-advance economy," Economics Working Papers 844, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2005.
  5. James B. Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  6. Clarida, R. & Gali, J. & Gertler, M., 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and some Theory," Working Papers 98-01, C.V. Starr Center for Applied Economics, New York University.
  7. 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.
  8. Seppo Honkapohja & Kaushik Mitra, . "Are Non-Fundamental Equilibria Learnable in Models of Monetary Policy?," Discussion Papers 01/05, Department of Economics, University of York.
  9. Lawrence J. Christiano & Massimo Rostagno, 2001. "Money Growth Monitoring and the Taylor Rule," NBER Working Papers 8539, National Bureau of Economic Research, Inc.
  10. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  11. Nicoletta Batini & Edward Nelson, 1999. "Optimal Horizons for Inflation Targeting," Computing in Economics and Finance 1999 1052, Society for Computational Economics.
  12. Carlstrom, Charles T. & Fuerst, Timothy S., 2004. "Learning and the central bank," Journal of Monetary Economics, Elsevier, vol. 51(2), pages 327-338, March.
  13. Bloise, Gaetano, 2001. "A Geometric Approach to Sunspot Equilibria," Journal of Economic Theory, Elsevier, vol. 101(2), pages 519-539, December.
  14. Ben S. Bernanke & Michael Woodford, 1997. "Inflation Forecasts and Monetary Policy," NBER Working Papers 6157, National Bureau of Economic Research, Inc.
  15. Grandmont Jean-michel, 1985. "Stabilizing competitive business cycles," CEPREMAP Working Papers (Couverture Orange) 8518, CEPREMAP.
  16. Lawrence J. Christiano & Sharon G. Harrison, 1996. "Chaos, Sunspots, and Automatic Stabilizers," NBER Working Papers 5703, National Bureau of Economic Research, Inc.
  17. Jean-Michel Grandmont & P, A, Pintus & R, De Vilder, 1997. "Capital-Labor Substitution and Competitive Nonlinear Endogenous Business Cycles," Working Papers 97-28, Centre de Recherche en Economie et Statistique.
  18. Andrew Levin & John C. Williams, 2000. "The Performance of Forecast-Based Monetary Policy Rules under Model Uncertainty," Econometric Society World Congress 2000 Contributed Papers 1781, Econometric Society.
  19. Bullard, James & Duffy, John, 1998. "Learning And The Stability Of Cycles," Macroeconomic Dynamics, Cambridge University Press, vol. 2(01), pages 22-48, March.
  20. Jess Benhabib & Stephanie Schmitt-Grohé & Martín Uribe, 2002. "Chaotic Interest-Rate Rules," American Economic Review, American Economic Association, vol. 92(2), pages 72-78, May.
  21. repec:cup:macdyn:v:2:y:1998:i:1:p:22-48 is not listed on IDEAS
  22. Grandmont, Jean-Michel, 1994. "Expectations formation and stability of large socioeconomic systems," CEPREMAP Working Papers (Couverture Orange) 9424, CEPREMAP.
  23. Costas Azariadis & Roger Guesnerie, 1986. "Sunspots and Cycles," Review of Economic Studies, Oxford University Press, vol. 53(5), pages 725-737.
  24. Charles T. Carlstrom & Timothy S. Fuerst, 2000. "Forward-looking versus backward-looking Taylor rules," Working Paper 0009, Federal Reserve Bank of Cleveland.
  25. James B. Bullard & John Duffy, 1995. "On learning and the stability of cycles," Working Papers 1995-006, Federal Reserve Bank of St. Louis.
  26. 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.
  27. Michael Woodford, 2000. "Pitfalls of Forward-Looking Monetary Policy," American Economic Review, American Economic Association, vol. 90(2), pages 100-104, May.
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