Bounded rationality, monetary policy, and macroeconomic stability

Ilabaca, Francisco and Meggiorini, Greta and Milani, Fabio,(UNSPECIFIED), Bounded rationality, monetary policy, and macroeconomic stability. , Economics Letters, UNSPECIFIED

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This paper estimates a Behavioral New Keynesian model to revisit the evidence that passive US monetary policy in the pre-1979 sample led to indeterminate equilibria and sunspot-driven fluctuations, while active policy after 1982, by satisfying the Taylor principle, was instrumental in restoring macroeconomic stability. The model assumes ‘‘cognitive discounting", i.e., consumers and firms pay less attention to variables further into the future. We estimate the model allowing for both determinacy and indeterminacy. The empirical results show that determinacy is preferred both before and after 1979. Even if monetary policy is found to react only mildly to inflation pre-Volcker, the substantial degrees of bounded rationality that we estimate prevent the economy from falling into indeterminacy.
Keywords : Behavioral New Keynesian model Cognitive discounting Estimation under determinacy and indeterminacy Taylor principle Active vs passive monetary policy, UNSPECIFIED
Journal or Publication Title: Economics Letters
Item Type: Article
Subjects: Ekonomi Pembangunan
Depositing User: Elok Inajati
Date Deposited: 26 Dec 2019 09:22
Last Modified: 26 Dec 2019 09:22

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