Kiel Working Papers, Kiel Institute for World Economics
No 1506:
On Determinacy and Learnability in a New Keynesian Model with Unemployment
Mewael F. Tesfaselassie and Eric Schaling
Abstract: We analyze determinacy and stability under learning
(E-stability) of rational expectations equilibria in the Blanchard and Galν
(2006, 2008) New-Keynesian model of inflation and unemployment, where labor
market frictions due to costs of hiring workers play an important role. We
derive results for alternative specifications of monetary policy rules and
alternative values of hiring costs as a percentage of GDP. Under low hiring
costs a typical part of the U.S. calibration for policy rules based on
current period inflation and unemployment our results are similar to those
of Bullard and Mitra (2002). However, we find that the region of
indeterminacy and E-instability in the policy space increases with the
hiring costs. So, higher hiring costs consistent with the European
'sclerotic' labor market institutions seem to play an important part in
explaining unemployment instability. Under lagged data based rules the area
where monetary policy delivers both determinacy and E-stability shrinks.
These rules perform worse according to these two dimensions when hiring
costs go up. Finally, under expectations-based rules unlike Bullard and
Mitra (2002) an additional explosive region is introduced. Here also the
scope for determinacy and E-stability oriented monetary policy decreases.
Interestingly under the same rule and European 'sclerotic' labor market
institutions we find that responding too much to expected inflation and
too little to expected unemployment may very well be self-defeating. When
hiring costs are large, a central bank that follows such a policy rule
could very easily end up in the worst-case scenario of both indeterminacy
and E-instability
Keywords: Monetary Policy Rules, Determinacy, Learning, E-Stability; (follow links to similar papers)
JEL-Codes: E52,; E31,; D84; (follow links to similar papers)
19 pages, March 2009
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