Determinacy, Learnability, and Monetary Policy Inertia

Abstract

Abstract.We document that monetary policy inertia can help alleviate problems of indeterminacy and non-existence of stationary equilibrium observed for some commonly-studied monetary policy rules. We also find that inertia promotes learnability of equilibrium. The context is a simple, forward-looking model of the macroeconomy widely used in the rapidly expanding literature in this area. We conclude that this might be an important reason why central banks in the industrialized economies display considerable inertia when adjusting monetary policy in response to changing economic conditions.

Robustifying learnability

“…As Bullard and Mitra [8] have emphasized, determinacy does not imply learnability, and indeterminacy does not imply a lack of learnability. We can address this question by postulating a representation for the REE that a learning agent might use.…”

“…7 In the kind of medium-to large-scale models that policy institutions use, these issues cannot be safely ignored. 8 Without taking away anything from the important contributions of Bullard and 7 A notable exception is Garratt and Hall [22], but even then the learning problem was constrained to exchange rate determination. The rest of the London Business School model that they used was taken as known.…”

“…The rest of the London Business School model that they used was taken as known. 8 Mitra [8] and Evans and Honkapohja [19], the choice of monetary policy rules must not only consider how they foster learnability in a given model but whether they do so for the broader class of models within which the true learning model might be found. Similarly, taking as given the true model, the initial beliefs of private agents can affect learnability both through the inclusion and exclusion of states to the PLM and through the initial values attached to parameters.…”

“…9 This is our concern in this paper: how can a policy maker deal with uncertainty in agents' learning mechanisms in the choice of his or her policy rule and thereby maximize the prospect that the economy will converge successfully on a rational expectations equilibrium? For this, we work with perturbations to the T-mapping described by equations (8) or systems like it. We take this up in the next subsection.…”

“…6 Bullard and Mitra [8] in an important paper show that higher persistence in instrument settingmeaning a large coefficient on the lagged instrument in a Taylor-type rule-can facilitate determinacy in the same class of models. Evans and Honkapohja [19] note similar problems in a wider class of rules and argue for feedback on structural shocks, although questions regarding the observability of such shocks leave open the issue of whether such a policy is implementable.…”