Determinacy, Learnability, Plausibility, and the Role of Money in New Keynesian Models
Recent mainstream monetary policy analysis focuses on rational expectation solutions that are uniquely stable. A number of recent studies have examined the question of whether typical New Keynesian (NK) models, with policy rules that satisfy the Taylor principle, also exhibit solutions with explosive inflation that cannot be ruled out by any transversality condition or any other generally accepted economic principle. This paper contributes to that debate by supporting and developing previous arguments suggesting that such explosive solutions are informationally infeasible. It also critiques prevailing notions of "determinancy" and outlines two alternative approaches to solution selection.
I am indebted to Marvin Goodfriend, Patrick Minford, Max Gillman, and Michael Magill for helpful suggestions. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research. At the time at which this paper was first drafted, I had a consulting relationship with the Federal Reserve Bank of Richmond. Also, an early version of the paper was presented at a conference held by the Swiss National Bank.