Working Paper: CEPR ID: DP9039
Authors: Patrick Minford; Naveen Srinivasan
Abstract: Forward-looking RE models such as the popular New Keynesian (NK) model do not provide a unique prediction about how the model economy behaves. We need some mechanism that ensures determinacy. McCallum (2011) says it is not needed because models are learnable only with the determinate solution and so the NK model, once learnt in this way, will be determinate. We agree: the only learnable solution that has agents converge on the true NK model is the bubble-free one. But once they have converged they must then understand the model and its full solution therefore including the bubble. Hence the learnability criterion still fails to pick a unique RE solution in NK models.
Keywords: determinacy; estability; learnability; new-keynesian; Taylor rule
JEL Codes: C62; D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| absence of a unique rational expectations solution in NK models (C62) | problematic models that do not provide unique predictions about economic behavior (E19) |
| determinacy can be ensured through mechanisms that modify the NK model internally (C62) | unique rational expectations equilibrium solution (D84) |
| agents converge on a stable solution (C62) | understanding the full model, including bubble solutions (C54) |
| learnability does not resolve the indeterminacy issue (C52) | agents realize the existence of the bubble solution (L85) |