Determination Of Equilibrium Research Articles

Limited (energy) supply, monetary policy, and sunspots

In a simple New Keynesian open economy setting, we analyze how local input shortages influence policy transmission and equilibrium determinacy. Shortages increase the elasticity of the local price of the scarce factor to domestic economic activity, affecting the cyclicality of marginal costs and incomes. As a result, the slope of both the Phillips and the IS curve is altered, crucially influencing monetary and fiscal policy transmission. These changes are affected by factor ownership and propensities to consume. Theoretically, shortages can also raise the risk of self-fulfilling fluctuations if a rising price of the constrained factor boosts incomes for agents with high propensities to consume. We illustrate these channels for the 2022 German energy crisis.

Limited (Energy) Supply, Monetary Policy, and Sunspots

In a simple New Keynesian open economy setting, we analyze how local input shortages influence policy transmission and equilibrium determinacy. Shortages increase the elasticity of the local price of the scarce factor to domestic economic activity, affecting the cyclicality of marginal costs and incomes. As a result, the slope of both the Phillips and the IS curve is altered, crucially influencing monetary and fiscal policy transmission. These changes are affected by factor ownership and propensities to consume. Theoretically, shortages can also raise the risk of self-fulfilling fluctuations if a rising price of the constrained factor boosts incomes for agents with high propensities to consume. We illustrate these channels for the 2022 German energy crisis.

On equilibrium determinacy in overlapping generations models with money

This paper provides a detailed analysis of the local determinacy of monetary and non-monetary steady states in Tirole (1985)’s classical two-period overlapping generations model with capital and production. We show that the sufficient condition for local determinacy in endowment economies provided by Scheinkman (1980) does not generalize to models with production: there are robust examples with arbitrary utility functions in which the non-monetary steady state is locally determinate or indeterminate. In contrast, the monetary steady state is locally determinate under fairly weak conditions.

Regulatory Capital Requirements, Inflation Targeting, and Equilibrium Determinacy

Regulatory Capital Requirements, Inflation Targeting, and Equilibrium Determinacy

Price Stickiness Heterogeneity and Equilibrium Determinacy

AbstractMonetary policy can achieve equilibrium determinacy with considerably weak responses to inflation under price stickiness heterogeneity. The result holds in a sticky‐price model with the constant elasticity‐of‐substitution aggregator and no trend inflation, and with a variable elasticity‐of‐substitution aggregator and historical trend inflation. The evidence in favor of the view that the U.S. economy was subject to self‐fulfilling expectations‐driven fluctuations in the pre‐Volcker period and the systematic shift in monetary policy was crucial in subsequent stabilization of inflation appears much weaker through the lens of price stickiness heterogeneity than previously concluded in the literature under price stickiness homogeneity.

Determinacy and E‐Stability with Interest Rate Rules at the Zero Lower Bound

AbstractWe evaluate and compare alternative interest rate rules, namely, average inflation targeting (AIT), price‐level targeting (PLT), and traditional inflation targeting rules, in a standard New Keynesian model that features recurring, transient zero lower bound regimes. We use determinacy and expectational stability (E‐stability) of equilibrium as the criteria for stabilization policy. We find that PLT policy, including nominal GDP targeting as a special case, most effectively promotes determinacy and E‐stability among the policy frameworks, whereas standard inflation targeting rules are prone to indeterminacy. AIT can induce determinacy and E‐stability effectively, provided the averaging window is sufficiently long.

Unconventional policy instruments in the New Keynesian model

Abstract This paper analyzes the use of unconventional policy instruments in New Keynesian setups in which the “divine coincidence” breaks down. The paper discusses the role of a second instrument that, in addition to the effect of conventional interest rate policy, may enter the Phillips curve, the investment–saving (IS) curve, and the welfare function, thus influencing inflation and output. The paper presents theoretical results on equilibrium determinacy, the inflation bias, the stabilization bias, and the optimal central banker’s preferences when both instruments are available. We show that the use of an unconventional instrument reduces the zone of equilibrium indeterminacy and may reduce the volatility of the economy. However, in some circumstances, committing to not use the second instrument may be welfare-improving (a result akin to Rogoff (Journal of International Economics 18(3-4), 199–217, 1985) example of counterproductive coordination). We also show that the optimal central banker should be both aggressive against inflation and interventionist in using the unconventional policy instrument, and we analyze the optimal central banker’s preferences when social preferences would yield equilibrium indeterminacy.

Tax policy and aggregate stability in an overlapping generations model

AbstractIn the context of a two‐period non‐monetary overlapping generations model with Cobb–Douglas preference and technological specifications, this paper explores the theoretical as well as quantitative interrelations between equilibrium (in)determinacy versus (i) a progressive tax schedule on wage income and (ii) a balanced‐budget rule with endogenous labour taxation. In sharp contrast to previous studies on a one‐sector representative‐agent macroeconomy, we find that both fiscal formulations can possibly operate as stabilizing instruments against cyclical fluctuations driven by agents' self‐fulfilling beliefs. The key policy implication of our no‐indeterminacy result is that depending on what is the underlying analytical environment, countercyclical income taxation may stabilize or destabilize the business cycle.

Wealth in utility, the Taylor principle and determinacy

Wealth in the utility function leads to the discounting to consumer’s Euler equation, enlarging determinacy regions and making it easier for the monetary authority to ensure equilibrium determinacy. We show that a passive policy rule which adjusts nominal interest rate by less than one-for-one in response to the inflation rate is able to rule out equilibrium indeterminacy, if properly specified, due to the presence of the demand channel of the Taylor principle and equilibrium determinacy. Furthermore, the extent to which monetary policy rule can be passive in order to avoid indeterminacy depends critically on the degree of preference over wealth as well as the underlying structures and parameters of the model.

Downward Nominal Wage Rigidity and Determinacy of Equilibrium

AbstractIt is well known in the literature that there is a tension between the frequency and duration of the zero lower bound (ZLB) on the nominal interest rate and the determinacy of equilibrium. In this short paper, I show that the presence of downward nominal wage rigidity (DNWR) resolves the tension by preventing a vicious cycle of price declines and output contractions under the ZLB. Consequently, the model with DNWR can replicate the long‐lived ZLB episodes observed in the data. It also implies a plausible size of output and inflation declines at the ZLB.

Cost channel, determinacy, and monetary policy in a two-country new Keynesian model

This study examines the role of the cost channel of monetary policy in a two-country new Keynesian model. The results demonstrate that the presence of the cost channel significantly affects worldwide equilibrium determinacy. A greater foreign cost channel widens worldwide equilibrium indeterminacy when home and foreign central banks respond strongly to inflation and the output gap. This phenomenon is exacerbated when a greater cost channel exists simultaneously in both countries. • We examine determinacy analysis in a two-country model with a cost channel. • The degree of the cost channel affects worldwide equilibrium determinacy. • The central bank s stronger reaction to inflation exacerbates indeterminacy. • This result is worsened whencost channels become more severe in both countries.

Community resilience: a useful concept for declining Icelandic communities?

In recent years, resilience has become an increasing focal point of community studies, in particular for settlements in the peripheral north, which face severe socio-economic and demographic challenges. Not all researchers and practitioners were equally excited about the transfer of this concept – deeply rooted in ecology – to the social sciences. Unsurprisingly there is a growing literature that engages critically with community resilience. This reflection takes up some of the main criticism and projects it onto Iceland; a country that can serve as magnifier in the exploration of community resilience for a variety of reasons. The main aim of this reflection is to keep the discussion going about theoretical and analytical insufficiencies within the field of community resilience. Shortcomings of existing definitions, the role of politics and agency as well as the determination of equilibria and the question of an endpoint to resilience are the essential strands of argumentation.

The Taylor Rule in Egypt: Is it Optimal? Is there Equilibrium Determinacy?

We investigate Egypt's Taylor rule (interest rate targeting) between 1976 and 2019 by including the main economic variables in its reaction function. Using the Taylor principle, we investigate Egypt’s monetary policy optimality. To this end, we conduct the generalized method of moments (GMM) estimation procedure with different Taylor rule specifications to deal with potential endogeneity among variables. Our GMM estimates reveal that the partial adjustment coefficient is of considerable magnitude, indicating the explanatory power of policy inertia on many total variations in the current values of the nominal interest rate in Egypt. Furthermore, the inflation gap coefficient violates the Taylor principle, making the policy procyclical and inflation "spiral" and inducing divergence from the long-run equilibrium. Therefore, Egypt's Taylor rule, and thus monetary policy, reflects the indeterminacy of equilibrium and is a passive and destabilizing policy. Besides, the output gap coefficient was unexpectedly found to be insignificant.

Progressive Taxation and Robust Monetary Policy

Abstract Recent monetary policy analyses show the profound implications of progressive taxation for monetary policy. This paper investigates how progressive taxation on labor income changes the effect of model uncertainty by introducing robust control. We obtained the following results: (i) Higher progressive taxation decreases the effect of model uncertainty on the inflation rate, output gap, and interest rate. (ii) A sufficiently higher progressive taxation brings the economy into the determinate equilibrium even if the model uncertainty is strong. According to these results, we conclude that progressive taxation on labor income is effective in mitigating the effects of model uncertainty in terms of variance and equilibrium determinacy.

Average inflation targeting and macroeconomic stability

I study the dynamic consequences of average inflation targeting in a tractable monetary model with sticky prices. I demonstrate that in the case in which the central bank attaches a relatively high weight on the distant past, average inflation targeting not only ensures local determinacy of equilibrium but is also capable of eradicating the liquidity trap problem—differently from standard Taylor rules. Specifically, I show the existence of a saddle connection from the deflationary steady state to the target steady state, along which reflation occurs in equilibrium due to limited and gradual increases in expected nominal interest rates.

Controlling chaos in New Keynesian macroeconomics

Abstract In a New Keynesian model, it is believed that combining active monetary policy using a Taylor rule with a passive fiscal rule can achieve local equilibrium determinacy. However, even with such policies, indeterminacy can occur from the emergence of a Shilnikov chaotic attractor in the region of the feasible parameter space. That result, shown by Barnett et al. (2022a), “Shilnikov Chaos, Low Interest Rates, and New Keynesian Macroeconomics,” Journal of Economic Dynamics and Control 134, and again by Barnett et al. (2022b), “Is Policy Causing Chaos in the United Kingdom,” Economic Modeling 108, implies that the presence of the Shilnikov chaotic attractor can cause the economy to drift towards and finally become stuck in the vicinity of lower-than-targeted inflation and nominal interest rates. The result can become the source of a liquidity trap phenomenon. We propose policy options for eliminating or controlling Shilnikov chaotic dynamics to help the economy escape from the liquidity trap or avoid drifting into it in the first place. We consider ways to eliminate or control the chaos by replacing the usual Taylor rule by an alternative policy design without interest rate feedback, such as a Taylor rule with monetary quantity feedback, an active fiscal policy rule with passive monetary rule, or an open loop policy without feedback. We also consider approaches that retain the Taylor rule with interest rate feedback and the associated Shilnikov chaos, while controlling the chaos through a well-known engineering algorithm using a second policy instrument. We find that a second instrument is needed to incorporate a long-run terminal condition missing from the usual myopic Taylor rule.

CONSISTENT EXPECTATIONS EQUILIBRIA IN MARKOV REGIME SWITCHING MODELS AND INFLATION DYNAMICS

AbstractWe study the existence of Stochastic Consistent Expectations Equilibria (SCEE) in linear Markov regime switching models. An SCEE exists when the model‐implied mean and first‐order autocorrelation coincide with those predicted by the agents via misspecified forecasting rules. For a simple regime‐switching monetary policy model, the parametric space where at least one SCEE exists is rather wide, and may extend well beyond the rational expectations equilibrium determinacy frontier. Misspecified expectations combined with regime switching yield a strong endogenous amplification mechanism that help generate the near unit root dynamics for inflation observed in the United States before the Great Moderation.

Is fiscal austerity really self‐defeating?

AbstractThis paper analyzes local and global equilibrium dynamics in an optimizing endogenous growth model under expenditure‐based fiscal austerity feedback policies expressed relative to the private capital stock—prescribing spending cuts in reaction to public debt accumulation. Because the present value of equilibrium primary surpluses turns to be a nonlinear function of debt, two steady state equilibria are shown to emerge, one exhibiting low debt and high growth, one exhibiting high debt and low growth. Local analysis reveals that the low‐debt/high‐growth steady state is saddle‐path stable while the high‐debt/low‐growth steady state is unstable—the latter thus indicating the possibility of self‐defeating austerity, characterized by off‐equilibrium upward spirals in debt because of persistent policy‐induced adverse effects on growth dividends and fiscal revenues. However, when global nonlinear dynamics are taken into account, it is demonstrated that the two steady states are endogenously connected. In particular, global analysis reveals that even if the high‐debt/low‐growth steady state is locally unstable, there exists a unique and possibly nonmonotonic saddle connection making the economy converge to the low‐debt/high‐growth steady state. The existence of the saddle connection guarantees global determinacy of perfect foresight equilibrium should the high‐debt/low‐growth steady state be a node, ruling out multiple explosive paths incompatible with the government's intertemporal budget constraint and the private agents' transversality condition. The foregoing results are robust with respect to the adoption of an output‐based—rather than a capital‐based—policy function as long as the rule is nonlinear and sufficiently reactive to debt changes.

Optimal control in the New Keynesian model with monetary and fiscal policy interactions

Dynamics of the New Keynesian model in continuous time with the Rotemberg pricing mechanism is considered within a framework of an optimal control problem. Various regimes of monetary and fiscal policy (‘active’ and ‘passive’) can lead to unstable dynamics in the economy. Parameters of the Taylor rules for both monetary and fiscal policies determine conditions for local equilibrium determinacy. Mapping out the ranges of the Taylor coefficient values where local determinacy cannot be obtained allows to control the economic system by controlling these parameters.

Determinacy and E-Stability with Interest Rate Rules at the Zero Lower Bound

We evaluate and compare alternative monetary policy rules, namely average inflation targeting, price level targeting, and traditional inflation targeting rules, in a standard New Keynesian model that features recurring, transient zero lower bound regimes. We use determinacy and expectational stability (E-stability) of equilibrium as the criteria for stabilization policy. We find that price level targeting policy, including nominal income targeting as a special case, most effectively promotes determinacy and E-stability among the policy frameworks, whereas standard inflation targeting rules are prone to indeterminacy. Average inflation targeting can induce determinacy and E-stability effectively, provided the averaging window is sufficiently long.