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Bounded Rationality, Monetary Policy, and Macroeconomic Stability

Francisco Ilabaca (), Greta Meggiorini () and Fabio Milani ()
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Greta Meggiorini: Department of Economics, University of California-Irvine

No 181906, Working Papers from University of California-Irvine, Department of Economics

Abstract: 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; Myopia; Estimation under determinacy and indeterminacy; Taylor principle; Active vs passive monetary policy (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 E58 E70 (search for similar items in EconPapers)
Pages: 9 pages
Date: 2019-06
New Economics Papers: this item is included in nep-cba, nep-cbe, nep-dge, nep-mac, nep-mon and nep-upt
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Journal Article: Bounded rationality, monetary policy, and macroeconomic stability (2020) Downloads
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