Thursday, July 16, 2015

Learning and New Keynesian Models.

John Barrdear at the Bank of England just posted an interesting paper, Towards a New Keynesian theory of the price level. Like Garcia Schmidt and Woodford, it changes the information structure of the standard model to avoid the standard model's problems.
Modifying the standard New-Keynesian model to replace firms' full information and sticky prices with flexible prices and dispersed information, and imposing mild and plausible restrictions on the monetary authority's decision rule, produces the striking results that (i) there exists a unique and globally stable steady-state rate of inflation, despite the possibility of a lower bound on nominal interest rates; and (ii) in the vicinity of steady-state, the price level is determinate (and not just the rate of inflation), despite the central bank targeting inflation. ... The model admits a determinate, stable solution with no role for sunspot shocks when the monetary authority responds by less than one-for-one to changes in expected inflation, including under an interest rate peg....
I haven't read this one yet either. I'm posting for anyone following these issues. Like Garcia Schmidt and Woodford, I also hope that others will read the papers and help to figure out if they really work as advertised.


  1. "In fact, however, the crisis itself, and even more the developments that followed, have been anything but puzzling. Again and again, things have played out pretty much the way you would have expected if you (a) understood and took seriously basic Hicks/Keynes macroeconomics and (b) paid attention to the relevant economic history." (Paul Krugman, July 15)

    There is some suspicion that this obsession with unique equilibria and sunspots might be a replay of questionable productivity in the macro-economic profession before the implementation of quantitative easing policies in 2008 (of which 30 years of theoretical "development" offered absolutely nothing of practical or any other value to policy-makers when it came to The Crunch). It might be time for a congressional hearing on what is going on in the profession, perhaps with some cross examination by mathematicians, hard scientists, philosophers and historians.

  2. Gotta agree. No idea about why the result that the inflation rated is actually determinate in their models surprises these authors.
    Multiple equilibria exist in a lot of markets. Gee, the very basics of macroeconomics is the existence of multiple equilibria: the ordinary long-run full employment and the short-run underemployment equilibrium.
    Or take labour markets, due to efficiency wage reasons they do not work like spot markets (employment is a long-run thingy, so hiring is like an investment for a firm) so their is no spot market price but a range of wages that would clear the labour market.

    But some economists do non-linear multiple equilibria stuff because it is "cute" and "mathy" and not because it provides any insides into what is actually going on in the real world.


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