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Investment and Monetary Policy: Learning and Determinacy of Equilibrium

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  • John Duffy
  • Wei Xiao

Abstract

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.

Suggested Citation

  • John Duffy & Wei Xiao, 2007. "Investment and Monetary Policy: Learning and Determinacy of Equilibrium," Working Paper 324, Department of Economics, University of Pittsburgh, revised Aug 2008.
    • Handle: RePEc:pit:wpaper:324
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    References listed on IDEAS

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    1. 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.
    2. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
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    5. Marc Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
    6. Dupor, Bill, 2001. "Investment and Interest Rate Policy," Journal of Economic Theory, Elsevier, vol. 98(1), pages 85-113, May.
    7. 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.
    8. 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, vol. 84(Q III), pages 47-64.
    9. 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.
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    Cited by:

    1. Gasteiger, Emanuel, 2011. "Heterogeneous expectations, Taylor rules and the merit of monetary policy inertia," MPRA Paper 31004, University Library of Munich, Germany.
    2. George W. Evans & Seppo Honkapohja, 2009. "Expectations, Learning and Monetary Policy: An Overview of Recent Research," Central Banking, Analysis, and Economic Policies Book Series, in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series (ed.),Monetary Policy under Uncertainty and Learning, edition 1, volume 13, chapter 2, pages 027-076, Central Bank of Chile.
    3. Raghbendra Jha & Varsha S. Kulkarni, 2012. "Inflation Volatility and the Inflation-Growth Tradeoff in India," ASARC Working Papers 2012-11, The Australian National University, Australia South Asia Research Centre.
    4. Luhan, Wolfgang J. & Scharler, Johann, 2013. "Monetary Policy, Inflation Illusion and the Taylor Principle – An Experimental Study," Ruhr Economic Papers 402, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.

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    More about this item

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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