Dennis, Richard and Kirsanova, Tatiana (2010): Expectations Traps and Coordination Failures: Selecting among Multiple Discretionary Equilibria.

PDF
MPRA_paper_24616.pdf Download (362kB)  Preview 
Abstract
Discretionary policymakers cannot manage privatesector expectations and cannot coordinate the actions of future policymakers. As a consequence, expectations traps and coordination failures can occur and multiple equilibria can arise. To utilize the explanatory power of models with multiple equilibria it is �first necessary to understand how an economy arrives to a particular equilibrium. In this paper, we employ notions of learnability, selfenforceability, and properness to motivate and develop a suite of equilibrium selection criteria. Central among these criteria are whether the equilibrium is learnable by private agents and jointly learnable by private agents and the policymaker. We use two New Keynesian policy models to identify the strategic interactions that give rise to multiple equilibria and to illustrate our equilibrium selection methods. Importantly, unless the Paretopreferred equilibrium is learnable by private agents, we �find little reason to expect coordination on that equilibrium.
Item Type:  MPRA Paper 

Original Title:  Expectations Traps and Coordination Failures: Selecting among Multiple Discretionary Equilibria 
Language:  English 
Keywords:  Discretionary policymaking, multiple equilibria, coordination, equilibrium selection 
Subjects:  E  Macroeconomics and Monetary Economics > E5  Monetary Policy, Central Banking, and the Supply of Money and Credit > E52  Monetary Policy E  Macroeconomics and Monetary Economics > E6  Macroeconomic Policy, Macroeconomic Aspects of Public Finance, Macroeconomic Policy, and General Outlook > E61  Policy Objectives; Policy Designs and Consistency; Policy Coordination C  Mathematical and Quantitative Methods > C6  Mathematical Methods; Programming Models; Mathematical and Simulation Modeling > C62  Existence and Stability Conditions of Equilibrium C  Mathematical and Quantitative Methods > C7  Game Theory and Bargaining Theory > C73  Stochastic and Dynamic Games; Evolutionary Games; Repeated Games 
Item ID:  24616 
Depositing User:  Tatiana Kirsanova 
Date Deposited:  25. Aug 2010 13:52 
Last Modified:  11. Feb 2013 23:47 
References:  Albanesi, S., Chari, V., and L. Christiano, (2003), "Expectation Traps and Monetary Policy", Review of Economic Studies, 70, pp. 715741. Anderson, E., Hansen, L., McGrattan, E., and T. Sargent, (1996), "Mechanics of Forming and Estimating Dynamic Linear Economies" in Amman, H., Kendrick, D., and J. Rust(eds) Handbook of Computational Economics, Volume 1, Chapter 4, North Holland, New York. Backus, D., and J. Driffill, (1986), "The Consistency of Optimal Policy in Stochastic Rational Expectations Models," Centre for Economic Policy Research Discussion Paper #124. Barro, R., and D. Gordon, (1983), "Rules, Discretion and Reputation in a Model of Monetary Policy," Journal of Monetary Economics, 12, pp. 101121. Benhabib, J., and R. Farmer, (1999), "Indeterminacy and Sunspots in Macroeconomics," in Taylor, J., and M. Woodford, (eds), Handbook of Macroeconomics, Elsevier, Chapter 6, pp. 387448. Bernheim, D., Peleg, B., and M. Whinston, (1987), "CoalitionProof Nash Equilibria: I. Concepts," Journal of Economic Theory, 42, pp. 112. Bernheim, D., and M. Whinston, (1987), "CoalitionProof Nash Equilibria: II. Applications," Journal of Economic Theory, 42, pp.1329. Blake, A., and T. Kirsanova, (2007), "Discretionary Policy and Multiple Equilibria in LQ RE Models," University of Exeter Working Paper. Calvo, G., (1983), "Staggered Contracts in a UtilityMaximising Framework," Journal of Monetary Economics, 12, pp. 383398. Chari, V., and P. Kehoe, (1990), "Sustainable Plans," Journal of Political Economy, 98, 4, pp. 783802. Christiano, L., Eichenbaum, M., and C. Evans, (2005), "Nominal Rigidities and the Dynamic E¤ects of a Shock to Monetary Policy," Journal of Political Economy, 113, pp. 145. Chow, G., (1997), Dynamic Economics: Optimization by the Lagrange Method, Oxford University Press, Oxford. Clarida, R., Galí, J., and M. Gertler, (1999), "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, 37, pp. 16611707. Clements, D., and H. Wimmer, (2003), "Existence and Uniqueness of Unmixed Solutions of the DiscreteTime Algebraic Riccati Equation," Systems Control Letters, 50, pp. 343346. Cohen, D., and P. Michel, (1988), "How Should Control Theory be Used to Calculate a TimeConsistent Government Policy?" Review of Economic Studies, 55, pp. 263274. Cooper, R., and A. John, (1988), "Coordination Failures in New Keynesian Models," The Quarterly Journal of Economics, 103, 3, pp. 441463. Currie, D. and P. Levine, (1985), "Optimal Feedback Rules in an Open Economy Macromodel with Rational Expectations," European Economic Review, 27, pp. 141163. Currie, D. and P. Levine, (1993), "Rules, Reputation and Macroeconomic Policy Coordination," Cambridge University Press, Cambridge, UK. Davig, T., and E. Leeper, (2006), "Fluctuating Macro Policies and the Fiscal Theory," in NBER Macroeconomics Annual, MIT Press. Dennis, R., and U. Söderström, (2006), "How Important is Precommitment for Monetary Policy?" Journal of Money, Credit, and Banking, 38, 4, pp. 847872. de Zeeuw, A., and F. van der Ploeg, (1991), "Difference Games and Policy Evaluation: A Conceptual Framework," Oxford Economic Papers, 43, 4, pp. 612636. Dixit, A., and J. Stiglitz, (1977), "Monopolistic Competition and Optimum Product Diversity," American Economic Review Papers and Proceedings, 67, pp. 297308. Dotsey, M., and A. Hornstein, (2008), "On the Implementation of MarkovPerfect Interest Rate and Money Supply Rules: Global and Local Uniqueness," Federal Reserve Bank of Philadelphia Working Paper #0830. Eichenbaum, M., and J. Fisher, (2007), "Estimating the Frequency of Price Reoptimization in CalvoStyle Models," Journal of Monetary Economics, 54, pp. 20322047. Evans, G., (1985), "Expectational Stability and the Multiple Equilibria Problem in Linear Rational Expectations Models," The Quarterly Journal of Economics, 100, 4, pp. 12171233. Evans, G., (1986), "Selection Criteria for Models with NonUniqueness," Journal of Monetary Economics, 18, pp. 147157. Evans, G., (2001), "Expectations in Macroeconomics: Adaptive versus Eductive Learning," Revue Economique, 52, 3, pp. 573582. Evans, G., R. Guesnerie, (1993), "Rationalizability, Strong Rationality, and Expectational Stability," Games and Economic Behavior, 5, pp. 632�646. Evans, G., R. Guesnerie, (2003), "Coordination on SaddlePath Solutions, The Eductive Viewpoint: Linear Univariate Models," Macroeconomic Dynamics, 7, pp. 42�62. Evans, G., and R. Guesnerie, (2005), "Coordination on SaddlePath Solutions: The Eductive Viewpoint" Linear Multivariate Models," Journal of Economic Theory, 124, pp. 202229. Evans, G., and S. Honkapohja, (2001), Learning and Expectations in Macroeconomics, Princeton University Press, Princeton. Guesnerie, R., and M. Woodford, (1992), "Endogenous Fluctuations," in Laffont, JJ.(ed), Advances in Economic Theory, Cambridge University Press, Cambridge. Ireland, P., (1997), "Sustainable Monetary Policies," Journal of Economic Dynamics and Control, 22, pp. 87108. Jensen, H., (2002), "Targeting Nominal Income Growth or Inflation?" American Economic Review, 92, 4, pp. 928956. Kurozumi, T., (2008), "Optimal Sustainable Monetary Policy," Journal of Monetary Economics, 55, pp. 12771289. King, R., and A. Wolman, (2004), "Monetary Discretion, Pricing Complementarity, and Dynamic Multiple Equilibria," The Quarterly Journal of Economics, 199, 4, pp. 1513 1553. Kydland, F., and E. Prescott, (1977), "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, 87, pp. 473492. Laub, A., (1979), "A Schur Method for Solving Algebraic Riccati Equations," IEEE Transactions on Automatic Control, 24, pp. 913921. Leeper, E., (1991), "Equilibria under "Active" and "Passive" Monetary and Fiscal Policies," Journal of Monetary Economics, 27, pp. 127147. Lucas, R., and N. Stokey, (1983), "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Journal of Monetary Economics, 12, pp. 5593. McCallum, B., (2007), "EStability visavis Determinacy Results for a Broad Class of Linear Rational Expectations Models," Journal of Economic Dynamics and Control, 31, pp. 13761391. Magnus, J., and H. Neudecker, (1988), Matrix Differential Calculus with Applications to Statistics and Econometrics, John Wiley and Sons, New York. Marcet, A., and T. Sargent, (1989), "Convergence of Least Squares Learning Mechanisms in SelfReferential Linear Stochastic Models," Journal of Economic Theory, 48, pp. 337 368. Myerson, R., (1978), "Refinements of the Nash Equilibrium Concept," International Journal of Game Theory, 7, pp. 7380. Oudiz, G., and J. Sachs, (1985), "International Policy Coordination in Dynamic Macroeconomic Models," in Buiter, W., and R. Marston, (eds), International Economic Policy Coordination, Cambridge University Press, Cambridge, pp. 275319. Ortigueira, S., and J. Pereira, (2009), "MarkovPerfect Optimal Fiscal Policy: The Case of Unbalanced Budgets," manuscript. Rogo¤, K., (1985), "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, 100, 4, pp. 11691189. Smets, F., and R. Wouters, (2003), "An Estimated Stochastic Dynamic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, 1, 5, pp. 11231175. Smets, F., and R. Wouters, (2007), "Shocks and Frictions in US Business Cycles: A Bayesian DSGE Approach," American Economic Review, 97, 3, pp. 586606. Sveen, T., and L. Weinke, (2007), "FirmSpecifi�c Capital, Nominal Rigidities, and the Taylor Principle," Journal of Economic Theory, 136, pp. 729737. van Zandweghe, W., and A. Wolman, (2010), "Discretionary Monetary Policy in the Calvo Model,"Federal Reserve Bank of Kansas City Working Paper #1006. Walsh, C., (1995), "Optimal Contracts for Central Bankers," American Economic Review, 85, 1, pp. 150�167. Walsh, C., (2003), "Speed Limit Policies: The Output Gap and Optimal Monetary Policy,"American Economic Review, 93, 1, pp. 265278. Woodford, M., (2003), Interest and Prices: Foundations of a Theory of Monetary Policy, Princeton University Press, Princeton, New Jersey. 
URI:  http://mpra.ub.unimuenchen.de/id/eprint/24616 