Working Paper: NBER ID: w10272
Authors: Jess Benhabib; Stephanie Schmitt-Grohe; Martin Uribe
Abstract: A growing empirical and theoretical literature argues in favor of specifying monetary policy in the form of Taylor-type interest rate feedback rules. That is, rules whereby the nominal interest rate is set as an increasing function of inflation with a slope greater than one around an intended inflation target. This paper shows that such rules can easily lead to chaotic dynamics. The result is obtained for feedback rules that depend on contemporaneous or expected future inflation. The existence of chaotic dynamics is established analytically and numerically in the context of calibrated economies. The battery of fiscal policies that has recently been advocated for avoiding global indeterminacy induced by Taylor-type interest-rate rules (such as liquidity traps) are shown to be unlikely to provide a remedy for the complex dynamics characterized in this paper.
Keywords: monetary policy; interest rate rules; chaos; economic stability
JEL Codes: E52; E31; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| active interest rate feedback rules (E43) | chaotic dynamics (C69) |
| inflation target being the only equilibrium level of inflation (E31) | complex dynamics (C69) |
| complex dynamics (C69) | not converge to a steady state or a liquidity trap (E19) |
| chaotic behavior induced by feedback rules (C69) | cannot be mitigated through traditional fiscal policies (E62) |