Monetary Policy and Determinacy: An Inquiry into Open Economy New Keynesian Macrodynamics

Abstract

Determinacy properties and conditions of equilibrium solution have been the subject of growing discussion and research in macroeconomics. Following in the footsteps of previous studies, we analyze determinacy in the baseline open-economy New Keynesian model developed by Gali and Monacelli in Rev Econ Stud 72(3):707–734 (Oxford University Press) (2005). We find that the open economy structure causes multifaceted behaviors in the system creating extra challenges for policy making. The degree of openness significantly affects determinacy properties of equilibrium under various forms and timing of monetary policy rules. Conditions for the uniqueness and local stability of equilibria are established. Determinacy diagrams are constructed to display the regions of unique and multiple equilibria. Numerical analyses are performed to confirm the theoretical results. Limit cycles and periodic behaviors are possible, but in some cases only for unrealistic parameter settings. Complex structures of open economies require rigorous policy design to achieve optimality.