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Determinacy, Learnability, and Monetary Policy Inertia

We document that monetary policy inertia can help alleviate problems of indeterminacy and non-existence of stationary equilibrium observed for some commonly-studied monetary policy rules. We also find that inertia promotes learnability of equilibrium. The context is a simple, forward-looking model of the macroeconomy widely used in the rapidly expanding literature in this area. We conclude that this might be an important reason why central banks in the industrialized economies display considerable inertia when adjusting monetary policy in response to changing economic conditions.

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File URL: http://www.rhul.ac.uk/economics/Research/WorkingPapers/pdf/dpe0414.pdf
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Paper provided by Department of Economics, Royal Holloway University of London in its series Royal Holloway, University of London: Discussion Papers in Economics with number 04/14.

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Length: 42 pages
Date of creation: Jul 2004
Date of revision: Jul 2004
Handle: RePEc:hol:holodi:0414
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  1. 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.
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  9. McCallum, Bennett T., 1999. "Issues in the design of monetary policy rules," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 23, pages 1483-1530 Elsevier.
  10. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  11. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
  12. Ben S. Bernanke & Michael Woodford, 1997. "Inflation forecasts and monetary policy," Proceedings, Federal Reserve Bank of Cleveland, pages 653-686.
  13. Glenn D. Rudebusch, 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Working Papers in Applied Economic Theory 95-02, Federal Reserve Bank of San Francisco.
  14. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April.
  15. Fuhrer, Jeffrey C & Moore, George R, 1995. "Monetary Policy Trade-offs and the Correlation between Nominal Interest Rates and Real Output," American Economic Review, American Economic Association, vol. 85(1), pages 219-39, March.
  16. Caplin, Andrew & Leahy, John, 1996. "Monetary Policy as a Process of Search," American Economic Review, American Economic Association, vol. 86(4), pages 689-702, September.
  17. Julio J. Rotemberg & Michael Woodford, 1999. "Interest Rate Rules in an Estimated Sticky Price Model," NBER Chapters, in: Monetary Policy Rules, pages 57-126 National Bureau of Economic Research, Inc.
  18. McCallum, Bennett T., 1983. "On non-uniqueness in rational expectations models : An attempt at perspective," Journal of Monetary Economics, Elsevier, vol. 11(2), pages 139-168.
  19. Roger E. A. Farmer, 1999. "Macroeconomics of Self-fulfilling Prophecies, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062038, June.
  20. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 2003. "Backward-Looking Interest Rate Rules, Interest Rate Smoothing and Macroeconomic Instability," CEPR Discussion Papers 3928, C.E.P.R. Discussion Papers.
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  23. Clarida, Richard & Gali, Jordi & Gertler, Mark, 1998. "Monetary policy rules in practice Some international evidence," European Economic Review, Elsevier, vol. 42(6), pages 1033-1067, June.
  24. Peter Isard & Douglas Laxton & Ann-Charlotte Eliasson, 1999. "Simple Monetary Policy Rules Under Model Uncertainty," International Tax and Public Finance, Springer, vol. 6(4), pages 537-577, November.
  25. 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.
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