The Calm Policymaker
56 Pages Posted: 27 Mar 2017
Date Written: March 24, 2017
Determinacy is ensured in the New Keynesian model when firms face imperfect common knowledge, regardless of whether the Taylor principle is satisfied. Strategic complementarity in pricing and idiosyncratic noise in firms’ signals, however small, are together sufficient to eliminate backward-looking solutions without appealing to the assumptions of Blanchard and Kahn (1980). Standard solutions emerge when the Taylor principle is followed, but when the policymaker demurs, the price level — and not just inflation — is stationary. A unique and stable solution also emerges with the interest rate pegged to its steady-state value, in contrast to Sargent and Wallace (1975).
Keywords: Dispersed information, imperfect common knowledge, New Keynesian, indeterminacy, Blanchard-Kahn, Taylor rules, Taylor principle, interest rate peg
JEL Classification: D84, E31, E52
Suggested Citation: Suggested Citation