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Heterogeneous expectations, Taylor rules and the merit of monetary policy inertia

  • Gasteiger, Emanuel

We present new results for the performance of Taylor rules in a New Keynesian model with heterogeneous expectations. Agents have either rational or adaptive expectations. We find that depending on the particular rule, expectational heterogeneity can create or increase the set of policies that leads to local explosiveness. This is a new level of destabilization compared to what is known. In addition, we demonstrate that policy inertia is an effective tool to safeguard the economy against local explosiveness. Thus, we provide a rationalization for central banks to adjust interest rates with notable inertia in response to shocks.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 31004.

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Date of creation: 10 May 2011
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Handle: RePEc:pra:mprapa:31004
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  1. Evans, George W. & McGough, Bruce, 2005. "Monetary policy and stable indeterminacy with inertia," Economics Letters, Elsevier, vol. 87(1), pages 1-7, April.
  2. Bennett T. McCallum, 2008. "Inflation Determination with Taylor Rules: Is New Keynesian Analysis Critically Flawed?," NBER Working Papers 14534, National Bureau of Economic Research, Inc.
  3. John H. Cochrane, 2007. "Determinacy and Identification with Taylor Rules," NBER Working Papers 13409, National Bureau of Economic Research, Inc.
  4. Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
  5. John Duffy & Wei Xiao, 2007. "Investment and Monetary Policy: Learning and Determinacy of Equilibrium," Working Papers 324, University of Pittsburgh, Department of Economics, revised Aug 2008.
  6. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
  7. Preston, Bruce, 2005. "Learning about Monetary Policy Rules when Long-Horizon Expectations Matter," MPRA Paper 830, University Library of Munich, Germany.
  8. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  9. Branch, William A. & McGough, Bruce, 2009. "A New Keynesian model with heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 33(5), pages 1036-1051, May.
  10. 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.
  11. Bruce McGough & Glenn D. Rudebusch & John C. Williams, 2004. "Using a long-term interest rate as the monetary policy instrument," Working Paper Series 2004-22, Federal Reserve Bank of San Francisco.
  12. Evans, George W. & McGough, Bruce, 2003. "Monetary policy, indeterminacy and learning," CFS Working Paper Series 2003/37, Center for Financial Studies (CFS).
  13. Kaushik Mitra & James Bullard, 2004. "Determinacy, Learnability, and Monetary Policy Inertia," Royal Holloway, University of London: Discussion Papers in Economics 04/14, Department of Economics, Royal Holloway University of London, revised Jul 2004.
  14. Bullard, James & Mitra, Kaushik, 2002. "Learning about monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1105-1129, September.
  15. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  16. 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.
  17. Binder,M. & Pesaran,H.M., 1995. "Multivariate Rational Expectations Models and Macroeconomic Modelling: A Review and Some New Results," Cambridge Working Papers in Economics 9415, Faculty of Economics, University of Cambridge.
  18. George Evans, 2005. "The design of monetary and fiscal policy: a global perspective - comments," Proceedings, Federal Reserve Bank of San Francisco.
  19. 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.
  20. John B. Taylor, 1999. "Monetary Policy Rules," NBER Books, National Bureau of Economic Research, Inc, number tayl99-1, October.
  21. William A. Branch, 2004. "The Theory of Rationally Heterogeneous Expectations: Evidence from Survey Data on Inflation Expectations," Economic Journal, Royal Economic Society, vol. 114(497), pages 592-621, 07.
  22. Klein, Paul, 2000. "Using the generalized Schur form to solve a multivariate linear rational expectations model," Journal of Economic Dynamics and Control, Elsevier, vol. 24(10), pages 1405-1423, September.
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