Determinacy in New Keynesian Models: A Role for Money after All?

23 Pages Posted: 24 Aug 2010

See all articles by Patrick Minford

Patrick Minford

Cardiff University Business School; Centre for Economic Policy Research (CEPR)

Naveen Srinivasan

Cardiff University Business School

Date Written: August 2010

Abstract

The New-Keynesian Taylor-Rule model of inflation determination with no role for money is incomplete. As Cochrane (2007a,b) argues, it has no credible mechanism for ruling out bubbles (or deal with the non uniqueness problem that arises when the Taylor principle is violated) and as a result fails to provide a reason for private agents to pick a unique stable path. We propose a way forward. Our proposal is in effect that the New-Keynesian model should be formulated with a money demand and money supply function. It should also embody a terminal condition for money supply behaviour. If indeterminacy of stable (or unstable paths) occurred the central bank would switch to a money supply rule explicitly designed to stop it via the terminal condition. This would be therefore a 'threat/trigger strategy' complementing the Taylor Rule - only to be invoked if inflation misbehaved. Thus we answer the criticisms levelled at the Taylor Rule that it has no credible mechanism for dealing with these issues. However it does imply that money cannot be avoided in the new Keynesian set-up, contrary to Woodford (2008).

Keywords: Determinacy, Money Supply, New-Keynesian, Taylor Rule, Terminal Condition

JEL Classification: E31, E52, E58

Suggested Citation

Minford, Patrick and Srinivasan, Naveen K., Determinacy in New Keynesian Models: A Role for Money after All? (August 2010). CEPR Discussion Paper No. DP7960. Available at SSRN: https://ssrn.com/abstract=1661563

Patrick Minford (Contact Author)

Cardiff University Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom
+44 29 2087 5728 (Phone)
+44 29 2087 4419 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Naveen K. Srinivasan

Cardiff University Business School ( email )

Colum Drive
Aberconway Building
Cardiff CF10 3EU
United Kingdom
+44 029 2087 6545 (Phone)
+44 029 2087 4419 (Fax)

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