Working Paper: NBER ID: w28881
Authors: Georgemarios Angeletos; Chen Lian
Abstract: Our understanding of monetary policy is complicated by an equilibrium-selection conundrum: because the same path for the nominal interest rate can be associated with multiple equilibrium paths for inflation and output, there is a long-standing debate about what the right equilibrium selection is. We offer a potential resolution by showing that small frictions in social memory and intertemporal coordination can remove the indeterminacy. Under our perturbations, the unique surviving equilibrium is the same as that selected by the Taylor principle, but it no more relies on it; monetary policy is left to play only a stabilization role; and fiscal policy needs to be Ricardian, even when monetary policy is passive.
Keywords: Monetary Policy; Fiscal Policy; Indeterminacy; New Keynesian Model
JEL Codes: D8; E4; E5; E7
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| perturbations in social memory (D91) | unique rational expectations equilibrium (D84) |
| small frictions in social memory (Z13) | resolution of indeterminacy in New Keynesian model (E12) |
| lack of perfect knowledge about past shocks (D80) | current economic outcomes (E66) |
| traditional reliance on Taylor principle (C51) | equilibrium selection (C62) |
| fiscal policy (E62) | inflation outcomes (E31) |