Is policy causing chaos in the United Kingdom?

Abstract

We study the stability properties and conditions for the onset of Shilnikov chaos in the UK New Keynesian macroeconomy, as well as the shifts in equilibrium dynamics under various policy regimes. Shilnikov chaos emerges for a restricted part of the free parameter space in the baseline rational expectations UK model with no regime switching. Chaos did not occur, when the UK's central bank showed a weak response to inflation in the high-inflation regime, while it appears easily in the low-inflation regime associated with the central bank's use of aggressive monetary policy in recent years. As a policy alternative for restoring uniqueness, the local analysis proposes tightening the monetary policy rule via the Taylor coefficient along with passive fiscal policy. But we find that doing so could hasten the emergence of Shilnikov's chaotic dynamics. The magnitude of the Taylor coefficient thus becomes central in attaining the desired long run steady-state.