Capital and Macroeconomic Instabilty in a Discrete-Time Model with Forward-Looking Interest Rate Rules

37 Pages Posted: 7 Feb 2007

See all articles by Kevin X. D. Huang

Kevin X. D. Huang

Federal Reserve Bank of Philadelphia; Vanderbilt University - College of Arts and Science - Department of Economics

Qinglai Meng

The Chinese University of Hong Kong (CUHK) - Department of Economics

Date Written: 2007

Abstract

The authors establish the necessary and sufficient conditions for local real determinacy in a discrete-time production economy with monopolistic competition and a quadratic price adjustment cost under forward-looking policy rules, for the case where capital is in exogenously fixed supply and the case with endogenous capital accumulation. Using these conditions, they show that (i) indeterminacy is more likely to occur with a greater share of payment to capital in value-added production cost; (ii) indeterminacy can be more or less likely to occur with constant capital than with variable capital; (iii) indeterminacy is more likely to occur when prices are modelled as jump variables than as predetermined variables; (iv) indeterminacy is less likely to occur with a greater degree of steady-state monopolistic distortions; and (v) indeterminacy is less likely to occur with a greater degree of price stickiness or with a higher steady-state inflation rate. In contrast to some existing research, the authors' analysis indicates that capital tends to lead to macroeconomic instability by affecting firms' pricing behavior in product markets rather than households' arbitrage activity in asset markets even under forward-looking policy rules.

Keywords: Capital, Indeterminacy, Forward-looking interest rate rules, Jump prices, Predetermined prices

JEL Classification: E12, E31, E52

Suggested Citation

Huang, Kevin X. D. and Meng, Qinglai, Capital and Macroeconomic Instabilty in a Discrete-Time Model with Forward-Looking Interest Rate Rules (2007). FRB of Philadelphia Working Paper No. 07-4. Available at SSRN: https://ssrn.com/abstract=961370 or http://dx.doi.org/10.2139/ssrn.961370

Kevin X. D. Huang (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

Vanderbilt University - College of Arts and Science - Department of Economics ( email )

Box 1819 Station B
Nashville, TN 37235
United States

Qinglai Meng

The Chinese University of Hong Kong (CUHK) - Department of Economics ( email )

Shatin, N.T.
Hong Kong

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