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Controlling Chaos in New Keynesian Macroeconomics

William Barnett (), Giovanni Bella, Taniya Ghosh (), Paolo Mattana and Venturi Venturi
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Giovanni Bella: University of Cagliari, Italy
Paolo Mattana: University of Cagliari, Italy
Venturi Venturi: University of Cagliari, Italy

No 202202, WORKING PAPERS SERIES IN THEORETICAL AND APPLIED ECONOMICS from University of Kansas, Department of Economics

Abstract: In a New Keynesian model, it is believed that combining active monetary policy using a Taylor rule with a passive fiscal rule can achieve local equilibrium determinacy. However, even with such policies, indeterminacy can occur from the emergence of a Shilnikov chaotic attractor in the region of the feasible parameter space. That result, shown by Barnett et al. (2021), implies that the presence of the Shilnikov chaotic attractor can cause the economy to drift towards and finally become stuck in the vicinity of lower-than-targeted inflation and nominal interest rates. The result can become the source of a liquidity trap phenomenon. We propose policy options for eliminating or controlling Shilnikov chaotic dynamics to help the economy escape from the liquidity trap or avoid drifting into it in the first place. We consider ways to eliminate or control the chaos by replacing the usual Taylor rule by an alternative policy design without interest rate feedback, such as a Taylor rule with monetary quantity feedback, an active fiscal policy rule with passive monetary rule, or an open loop policy without feedback. We also consider approaches that retain the Taylor rule with interest rate feedback and the associated Shilnikov chaos, while controlling the chaos through a well-known engineering algorithm using a second policy instrument. We find that a second instrument is needed to incorporate a long-run terminal condition missing from the usual myopic Taylor rule.

Keywords: Shilnikov chaos criterion; global indeterminacy; long-term un-predictability; liquidity trap; long run anchor. (search for similar items in EconPapers)
JEL-codes: C61 C62 E12 E52 E63 (search for similar items in EconPapers)
Date: 2022-01
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac and nep-mon
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