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Determinacy in New K eynesian Models: A Role for Money after All?
Author(s) -
Minford Patrick,
Srinivasan Naveen
Publication year - 2011
Publication title -
international finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.458
H-Index - 39
eISSN - 1468-2362
pISSN - 1367-0271
DOI - 10.1111/j.1468-2362.2011.01282.x
Subject(s) - determinacy , economics , keynesian economics , new keynesian economics , indeterminacy (philosophy) , money supply , inflation (cosmology) , uniqueness , taylor rule , monetary policy , monetarism , mathematical economics , central bank , law , physics , mathematical analysis , mathematics , quantum mechanics , theoretical physics , political science
The New Keynesian Taylor rule model of inflation determination with no role for money is incomplete. As Cochrane (2007a, b) argues, it has no credible mechanism for ruling out bubbles (or deal with the non‐uniqueness problem that arises when the Taylor principle is violated) and as a result fails to provide a reason for private agents to pick a unique stable path. We propose a way forward. Our proposal is in effect that the New Keynesian model should be formulated with a money demand and money supply function. It should also embody a terminal condition for money supply behaviour. If indeterminacy of stable (or unstable) paths occurred the central bank would switch to a money supply rule explicitly designed to stop it via the terminal condition. This would therefore be a ‘threat/trigger strategy’ complementing the Taylor rule – only to be invoked if inflation misbehaved. Thus, we answer the criticisms levelled at the Taylor rule that it has no credible mechanism for dealing with these issues. However, it does imply that money cannot be avoided in the New Keynesian setup, contrary to Woodford (2008).