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Active Interest Rate Rules and the Role of Stabilization Policy R&D Tax Credits

  • Vivaldo M. Mendes

    ()

    (ISCTE - Department of Economics and UNIDE-ERC)

  • Diana A. Mendes

    ()

    (ISCTE - Department of Quantitative Methods and UNIDE-StatMath)

Registered author(s):

    In a series of papers, Benhabib, Schmitt-Grohé and Uribe (2001a, 2001b, 2001c, 2002 and 2004) have shown that active interest rules may lead to very unexpected consequences: indeterminacy, deflation traps, large cyclical instability, and can even lead to chaotic dynamics under standard sets of parameter values. This paper explores this particular model model and puts forward four basic points: (i) the model developed by Benhabib and associates seems to suffer from serious drawbacks to be used as a theoretical benchmark to guide optimal monetary policy, as the more aggressive the central bank becomes, the more unstable the economy will be; (ii) the time span required to achieve successful control is generally small, by linear feedback techniques – the OGY method – without producing modifications to the original model, apart from locally changing its type of stability; (iii) ignorance about the true state of initial conditions are not a serious impediment to obtain control of the chaotic dynamics in the model; (iv) we argue that the conventional view of economic policy in nonlinear general equilibrium models – when endogenous fluctuations exist in optimizing models, the associated policy advice is laissez—faire – seems to be based on a misconception of chaos in general, and on the control of chaos in particular.

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    File URL: http://bru-unide.iscte.pt/RePEc/pdfs/ERCwp0208.pdf
    File Function: Second draft, 2007
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    Paper provided by ISCTE-IUL, Business Research Unit (BRU-IUL) in its series Working Papers Series 1 with number ercwp0208.

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    Length: 25 pages
    Date of creation: 15 Sep 2006
    Date of revision:
    Handle: RePEc:isc:iscwp1:ercwp0208
    Contact details of provider: Web page: http://bru-unide.iscte.pt/
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    1. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
    2. Marta Aloi & Hans Jorgen Jacobsen & Teresa Lloyd-Braga, 1998. "Endogenous Business Cycles and Stabilization Policies," Discussion Papers 00-06, University of Copenhagen. Department of Economics, revised Mar 2000.
    3. repec:ebl:ecbull:v:5:y:2003:i:10:p:1-7 is not listed on IDEAS
    4. Carl Chiarella & Xue-Zhong He, 2000. "Stability of Competitive Equilibria with Heterogeneous Beliefs and Learning," Research Paper Series 37, Quantitative Finance Research Centre, University of Technology, Sydney.
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    11. Guo, Jang-Ting & Lansing, Kevin J., 2002. "Fiscal Policy, Increasing Returns, And Endogenous Fluctuations," Macroeconomic Dynamics, Cambridge University Press, vol. 6(05), pages 633-664, November.
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    13. Lawrence J. Christiano & Sharon G. Harrison, 1996. "Chaos, sunspots, and automatic stabilizers," Working Paper Series, Macroeconomic Issues WP-96-16, Federal Reserve Bank of Chicago.
    14. Kaas, Leo, 1998. "Stabilizing chaos in a dynamic macroeconomic model," Journal of Economic Behavior & Organization, Elsevier, vol. 33(3-4), pages 313-332, January.
    15. Marco Airaudo & Luis-Felipe Zanna, 2004. "Endogenous Fluctuations in Open Economies: the Perils of Taylor Rules Revisited," Econometric Society 2004 Latin American Meetings 80, Econometric Society.
    16. Thomas Seegmuller, 2003. "Endogenous fluctuations and public services in a simple OLG economy," Economics Bulletin, AccessEcon, vol. 5(10), pages 1-7.
    17. Michael Kopel, 1997. "Improving the performance of an economic system: Controlling chaos," Journal of Evolutionary Economics, Springer, vol. 7(3), pages 269-289.
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