Reply to "Generalizing the Taylor Principle: A Comment"
NBER Working Paper No. 14919
Farmer, Waggoner, and Zha (2009) show that a new Keynesian model with a regime-switching monetary policy rule can support multiple solutions that depend only on the fundamental shocks in the model. Their note appears to find solutions in regions of the parameter space where there should be no bounded solutions, according to conditions in Davig and Leeper (2007). This puzzling finding is straightforward to explain: Farmer, Waggoner, and Zha (FWZ) derive solutions using a model that differs from the one to which the Davig and Leeper (DL) conditions apply. FWZ's multiple solutions rely on special assumptions about the correlation structure between fundamental shocks and policy regimes, blurring the distinction between "deep" parameters that govern behavior and the parameters that govern the exogenous shock processes, and making it difficult to ascribe any economic interpretation to FWZ's solutions.
This paper was revised on December 5, 2011