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Investment and Monetary Policy: Learning and Determinacy of Equilibrium

  • John Duffy
  • Wei Xiao

We examine determinancy and expectational stability (learnability) of rational expectations equilibrium (REE) in sticky price New Keynesian (NK) models of the monetary transmission mechanism. We consider three different New Keynesian models: a labor-only model and two models that add capital -- one where capital is allocated in an economy-wide rental market and another where demand for capital is firm-specific. We find that Bullard and Mitra's (2002, 2007) findings on determinacy and learnability of REE under various interest rate rules in the labor-only NK model do not always extend to models with capital. In particular, the Taylor principle, that the response of interest rates should be more than proportionate to changes in inflation, will not generally suffice to guarantee determinate and/or learnable equilibria in NK models with capital.

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Paper provided by University of Pittsburgh, Department of Economics in its series Working Papers with number 324.

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Date of creation: Jul 2007
Date of revision: Aug 2008
Handle: RePEc:pit:wpaper:324
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  1. Kaushik Mitra & James Bullard, . "Learning About Monetary Policy Rules," Discussion Papers 00/41, Department of Economics, University of York.
  2. 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.
  3. Marc Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
  4. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  5. Sveen, Tommy & Weinke, Lutz, 2007. "Firm-specific capital, nominal rigidities, and the Taylor principle," Journal of Economic Theory, Elsevier, vol. 136(1), pages 729-737, September.
  6. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  7. Michael Woodford, 2003. "Optimal Interest-Rate Smoothing," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 861-886.
  8. Michael Woodford, 2005. "Firm-Specific Capital and the New Keynesian Phillips Curve," International Journal of Central Banking, International Journal of Central Banking, vol. 1(2), September.
  9. Bill Dupor, 2000. "Investment and Interest Rate Policy," Econometric Society World Congress 2000 Contributed Papers 0007, Econometric Society.
  10. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
  11. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  12. Michael Woodford, 2001. "The Taylor Rule and Optimal Monetary Policy," American Economic Review, American Economic Association, vol. 91(2), pages 232-237, May.
  13. Kurozumi, Takushi & Van Zandweghe, Willem, 2008. "Investment, interest rate policy, and equilibrium stability," Journal of Economic Dynamics and Control, Elsevier, vol. 32(5), pages 1489-1516, May.
  14. Sveen, Tommy & Weinke, Lutz, 2005. "New perspectives on capital, sticky prices, and the Taylor principle," Journal of Economic Theory, Elsevier, vol. 123(1), pages 21-39, July.
  15. Jeffery D. Amato & Thomas Laubach, 1999. "The value of interest rate smoothing : how the private sector helps the Federal Reserve," Economic Review, Federal Reserve Bank of Kansas City, issue Q III, pages 47-64.
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