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Determinacy without the Taylor Principle

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  • George-Marios Angeletos
  • Chen Lian

Abstract

Our understanding of monetary policy is complicated by an equilibrium-selection conundrum: because the same path for the nominal interest rate can be associated with multiple equilibrium paths for inflation and output, there is a long-standing debate about what the right equilibrium selection is. We offer a potential resolution by showing that small frictions in social memory and intertemporal coordination can remove the indeterminacy. Under our perturbations, the unique surviving equilibrium is the same as that selected by the Taylor principle, but it no more relies on it; monetary policy is left to play only a stabilization role; and fiscal policy needs to be Ricardian, even when monetary policy is passive.

Suggested Citation

  • George-Marios Angeletos & Chen Lian, 2021. "Determinacy without the Taylor Principle," NBER Working Papers 28881, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:28881
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    3. Roulleau-Pasdeloup, Jordan, 2023. "Analyzing Linear DSGE models: the Method of Undetermined Markov States," Journal of Economic Dynamics and Control, Elsevier, vol. 151(C).

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    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E7 - Macroeconomics and Monetary Economics - - Macro-Based Behavioral Economics

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