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Instability in the basic New Keynesian model under limited information

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  • Escañuela Romana, Ignacio

Abstract

New solutions to the basic standard New Keynesian model are explored. I extend De Grauwe’s model (2012), distinguishing two types of agents and different expectations rules. The central bank fixes the rate of interest. Families and firms determine aggregated demand and supply. Neither of them follows the hypothesis of perfect rational expectations. However, Popper’s principle of rationality is applied. From a situation of limited information, even though they learn through rational processes, they are unable to understand their mutual behaviour. Therefore, the expectations in the three equations do not coincide. As a result, the solution does not tend to a single, stationary equilibrium. This conclusion does not depend on the hypothesis of the "animal spirits". Finally, the possibility of a successful learning process is studied. It is considered whether the central bank could learn from the data, finally reaching a stationary optimum equilibrium. The answer is no. The New Keynesian model seems to be basically unstable when agents have limited information. The problem lies in the impossibility to get adequate coordination.

Suggested Citation

  • Escañuela Romana, Ignacio, 2018. "Instability in the basic New Keynesian model under limited information," MPRA Paper 88015, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:88015
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • E10 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - General
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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