Stability in models of money and perfect foresight: implications of non-linearity

Abstract

In this paper we reconsider the rationale for the jump-variable technique, which is a standard component of linear rational expectations models. Using a simple monetary model for illustration, we argue that the traditional justification for jumps in the price level loses much of its force when money demand is non-linear. Instead, with perfect foresight and non-instantaneous price adjustment, the model gives rise to limit cycle behavior with endogenously determined jumps in inflation rates instead of jumps in the price level.