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Learning about Monetary Policy Rules when the Cost Channel Matters

  • Llosa Gonzalo

    (UCLA)

  • Tuesta Vicente

    ()

    (Banco Central de Reserva del Perú)

We study how the stability of rational expectations equilibrium may be affected by monetary policy when agents learn using adaptive learning (E-stability concept) and the cost channel of monetary policy matters. We focus on both instrumental taylor-type rules and optimal rules. We show, analytically, that standard instrument rules -contemporaneous and forecast based rules - can easily induce indeterminacy and expectational instability when the cost channel is present. Overall, a naive application of the Taylor principle in this setting could be misleading. Regarding optimal rules, we find that "expectational-based" rules, under discretion and commitment, do not always induce determinate and E-stable equilibrium. This result stands in contrast to the findings of Evans and Honkapohja (2003) for for the baseline “New Keynessian" model.

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Paper provided by Banco Central de Reserva del Perú in its series Working Papers with number 2007-014.

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Date of creation: Aug 2007
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Handle: RePEc:rbp:wpaper:2007-014
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  1. James Bullard & Kaushik Mitra, . "Determinacy, Learnability, and Monetary Policy Inertia," Discussion Papers 00/43, Department of Economics, University of York.
  2. Bruce Preston, 2003. "Learning about monetary policy rules when long-horizon expectations matter," Working Paper 2003-18, Federal Reserve Bank of Atlanta.
  3. Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen.
  4. Duffy, John & Xiao, Wei, 2004. "The value of interest rate stabilization polices when agents are learning," Working Papers 2004-02, University of New Orleans, Department of Economics and Finance.
  5. Ibrahim Chowdhury & Mathias Hoffmann & Andreas Schabert, . "Inflation Dynamics and the Cost Channel of Monetary Transmission," Working Papers 2003_19, Business School - Economics, University of Glasgow, revised Oct 2003.
  6. Evans, George W. & Honkapohja, Seppo, 1999. "Learning dynamics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 7, pages 449-542 Elsevier.
  7. 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.
  8. Bennett T. McCallum, 1981. "On Non-Uniqueness in Rational Expectations Models: An Attempt at Perspective," NBER Working Papers 0684, National Bureau of Economic Research, Inc.
  9. George W. Evans & Seppo Honkapohja, 2002. "Monetary Policy, Expectations and Commitment," University of Oregon Economics Department Working Papers 2005-11, University of Oregon Economics Department, revised 06 Apr 2005.
  10. James Bullard & Kaushik Mitra, 2002. "Learning about monetary policy rules," Working Papers 2000-001, Federal Reserve Bank of St. Louis.
  11. Barth, Marvin J III & Ramey, Valerie A, 2000. "The Cost Channel of Monetary Transmissions," University of California at San Diego, Economics Working Paper Series qt7rm5q9sk, Department of Economics, UC San Diego.
  12. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  13. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Wiley Blackwell, vol. 70(4), pages 807-824, October.
  14. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  15. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  16. Benhabib, Jess & Schmitt-Grohé, Stephanie & Uribe, Martín, 1999. "Monetary Policy and Multiple Equilibria," CEPR Discussion Papers 2316, C.E.P.R. Discussion Papers.
  17. Bennett T. McCallum, 2006. "E-Stability vis-a-vis Determinacy Results for a Broad Class of Linear Rational Expectations Models," NBER Working Papers 12441, National Bureau of Economic Research, Inc.
  18. Marc Paolo Giannoni & Michael Woodford, 2003. "How forward-looking is optimal monetary policy?," Proceedings, Federal Reserve Bank of Cleveland, pages 1425-1483.
  19. Takushi Kurozumi, 2006. "Determinacy and Expectational Stability of Equilibrium in a Monetary Sticky-Price Model with Taylor Rule," Bank of Japan Working Paper Series 06-E-2, Bank of Japan.
  20. 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.
  21. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  22. Bruckner, Matthias & Schabert, Andreas, 2003. "Supply-side effects of monetary policy and equilibrium multiplicity," Economics Letters, Elsevier, vol. 79(2), pages 205-211, May.
  23. James B. Bullard, 2006. "The learnability criterion and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 203-217.
  24. Surico, Paolo, 2008. "The Cost Channel Of Monetary Policy And Indeterminacy," Macroeconomic Dynamics, Cambridge University Press, vol. 12(05), pages 724-735, November.
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