On the Determinacy of Monetary Policy Under Expectational Errors

CDMA Working Paper No. 06/03

38 Pages Posted: 26 Mar 2006

See all articles by Jagjit S. Chadha

Jagjit S. Chadha

University of St. Andrews - School of Management

Luisa Corrado

University of Rome Tor Vergata Department of Economics and Finance

Date Written: April 2007

Abstract

Forward looking agents with expectational errors provide a problem for monetary policy. We show that under such conditions a standard interest rate rule may not achieve determinacy. We suggest a modification to the standard policy rule that guarantees determinacy in this setting, which involves the policy maker co-ordinating inflation dynamics by responding to each of past, current and expected inflation. We show that this solution maps directly into Woodford's (2000) timeless perspective. We trace the responses in an artificial economy and illustrate the extent to which macroeconomic persistence is reduced following the adoption of this rule.

Keywords: Expectational Errors, Indeterminacy, Monetary Policy Rules

JEL Classification: C63, C62, E00

Suggested Citation

Chadha, Jagjit S. and Corrado, Luisa, On the Determinacy of Monetary Policy Under Expectational Errors (April 2007). CDMA Working Paper No. 06/03. Available at SSRN: https://ssrn.com/abstract=891979 or http://dx.doi.org/10.2139/ssrn.891979

Jagjit S. Chadha

University of St. Andrews - School of Management ( email )

The Gateway
Gateway
St. Andrews, Fife KY16 9SS
United Kingdom
+44 1334 462440 (Phone)

HOME PAGE: http://www.st-andrews.ac.uk/economics/staff/pages/j.chadha.shtml

Luisa Corrado (Contact Author)

University of Rome Tor Vergata Department of Economics and Finance ( email )

Via Columbia n.2
Rome, rome 00100
Italy

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