Investment and Monetary Policy: Learning and Determinacy of Equilibrium

Abstract

We explore determinacy and expectational stability (learnability) of rational expectations equilibrium (REE) in New Keynesian (NK) models that include capital. Using a consistent calibration across three different models—labor-only, firm-specific capital, or an economy-wide rental market for capital, we provide a clear picture of when REE is determinate and learnable and when it is not under a variety of monetary policy rules. Our findings make a case for greater optimism concerning the use of such rules in NK models with capital. While Bullard and Mitra’s (2002, 2007) findings for the labor-only NK model do not always extend to models with capital, we show that determinate and learnable REE can be achieved in NK models with capital if there is (i) plausible capital adjustment costs, (ii) some weight given to output in the policy rule, and/or (iii) a policy of interest rate smoothing.