Towards a New Keynesian Theory of the Price Level

Abstract

Modifying the standard New-Keynesian model to replace firms' full information and sticky prices with flexible prices and dispersed information, and imposing mild and plausible restrictions on the monetary authority's decision rule, produces the striking results that (i) there exists a unique and globally stable steady-state rate of inflation, despite the possibility of a lower bound on nominal interest rates; and (ii) in the vicinity of steady-state, the price level is determinate (and not just the rate of inflation), despite the central bank targeting inflation. The specification of firms' signal extraction problem under dispersed information removes the need to make use of Blanchard-Kahn conditions to solve the model, thereby removing the need to adhere to the Taylor principle and consequently circumventing the critique of Cochrane (2011). The model admits a determinate, stable solution with no role for sunspot shocks when the monetary authority responds by less than one-for-one to changes in expected inflation, including under an interest rate peg. An extension to include incomplete information on the part of the central bank permits the consideration of (rational) errors of judgement on the part of policymakers and provides a theoretical basis for inertial policymaking without interest rate smoothing, in support of Rudebusch (2002Rudebusch ( , 2006.

Dynamics of Discrete Time Systems with a Hysteresis Stop Operator

“…In economics, hysteresis has been well documented in the relationship between the output of the economy and unemployment rate [5]. Hysteresis has been also closely associated with other stylized facts such as path dependence [8,22], stickiness of prices and information [6,19,38] , and heterostasis (multiplicity of equilibria) [14] that describe empirical economic data. An attempt to obtain quantitative models of these empirical observations naturally motivated the use of the play operator and more complex models of hysteresis developed in physics in the economic context.…”