Sunspots and Monetary Policy

Jagjit Chadha () and Luisa Corrado

Economics and Finance Discussion Papers from Economics and Finance Section, School of Social Sciences, Brunel University

Abstract: A monetary economy subject to expectational sunspots is prone to instability, in the sense of multiple rational expectations equilibria. We show how to modify the policy rule to guarantee stability in the presence of expectational sunspots. The policy-maker must co-ordinate inflation dynamics by targeting each of lagged, current and expected inflation. We show that this solution maps directly into the timeless perspective by Woodford. Finally, we trace the responses in an artificial sunspot economy to the adoption of our rule and illustrate the extent to which macroeconomic persistence is reduced.

Pages: 29 pages
Date: 2006-03
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