Working Paper: CEPR ID: DP2846
Authors: Seppo Honkapohja; Kaushik Mitra
Abstract: Recent models of monetary policy can have indeterminacy of equilibria. The indeterminacy property is often viewed as a difficulty of these models. We consider its significance using the learning approach to expectations formation by employing expectational stability as a robustness criterion for different equilibria. We derive the expectational stability and instability conditions for forward-looking multivariate models, both with and without lags, that cover a wide range of monetary policies proposed in the literature.
Keywords: Adaptive Learning; Monetary Policy; Stability; Sunspots
JEL Codes: D84; E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nonfundamental equilibria (D59) | understanding of monetary policy effectiveness (E52) |
| stability of nonfundamental equilibria (C62) | convergence towards stable equilibrium (C62) |
| forecast errors and expectation adjustments (C53) | convergence towards stable equilibrium (C62) |
| nonfundamental equilibria instability (D59) | support for inflation-targeting policies (E64) |
| pre-Volcker monetary policy (E52) | unlearnable equilibrium (C62) |
| post-Volcker period (E65) | learnable fundamental equilibrium (C62) |
| learnable fundamental equilibrium (C62) | lower inflation volatility (E31) |