Working Paper: NBER ID: w14919
Authors: Troy Davig; Eric M. Leeper
Abstract: Farmer, Waggoner, and Zha (2009) show that a new Keynesian model with a regime-switching monetary policy rule can support multiple solutions that depend only on the fundamental shocks in the model. Their note appears to find solutions in regions of the parameter space where there should be no bounded solutions, according to conditions in Davig and Leeper (2007). This puzzling finding is straightforward to explain: Farmer, Waggoner, and Zha (FWZ) derive solutions using a model that differs from the one to which the Davig and Leeper (DL) conditions apply. FWZ's multiple solutions rely on special assumptions about the correlation structure between fundamental shocks and policy regimes, blurring the distinction between "deep" parameters that govern behavior and the parameters that govern the exogenous shock processes, and making it difficult to ascribe any economic interpretation to FWZ's solutions.
Keywords: Taylor Principle; Monetary Policy; Rational Expectations; Equilibrium Determinacy
JEL Codes: C62; E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| future policy regime changes (O24) | current inflation volatility (E31) |
| policy behavior across different time frames (D78) | equilibrium outcomes (D51) |
| generalized Taylor principle (C61) | stability of inflation expectations (E31) |
| excessive passive behavior (D91) | violation of long-run Taylor principle (E61) |
| violation of long-run Taylor principle (E61) | multiple equilibria (D50) |