Working Paper: NBER ID: w18215
Authors: Bennett T. McCallum
Abstract: Recent mainstream monetary policy analysis focuses on rational expectation solutions that are uniquely stable. A number of recent studies have examined the question of whether typical New Keynesian (NK) models, with policy rules that satisfy the Taylor principle, also exhibit solutions with explosive inflation that cannot be ruled out by any transversality condition or any other generally accepted economic principle. This paper contributes to that debate by supporting and developing previous arguments suggesting that such explosive solutions are informationally infeasible. It also critiques prevailing notions of "determinancy" and outlines two alternative approaches to solution selection.
Keywords: New Keynesian Models; Monetary Policy; Determinacy; Learnability
JEL Codes: C61; C62; E37; E47
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy rules satisfying the Taylor principle (E61) | Explosive inflation paths (E31) |
| Explosive inflation paths (E31) | Lack of determinacy (D81) |
| Stable solution (C62) | Plausibility as a prediction of economic behavior (D01) |
| Unobserved shocks (D89) | Learnability of proposed solutions (C52) |
| Monetary policy rules (E52) | Inflation expectations (E31) |