Abstract
This paper focuses on two mechanisms under which interest-rate feed-back rules induce local indeterminacy in a closed economy with capital accumulation: arbitrage activity and the pricing channel. It shows that constrained investment, in the sense that it requires liquidity or that adjustment to the stock of capital is costly, is enough to induce indeterminacy if monetary policy follows a strictly passive interest rate rule. Determinacy of equilibrium is ensured under an active monetary policy stance. These results change when production externalities are introduced into the model so as to mimic the pricing channel in New Keynesian models. In this case, a policy stance that ensures determinacy is either active or strictly passive. In view of the contradicting results for the passive stance and the similar results for the active stance it is recommended that central banks act according to the active stance.
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I would like to thank Benny Bental, Dan Peled, Assaf Razin, Seminar Participants at Tel Aviv University, Hebrew University of Jerusalem Mount Scopus, Haifa Universiry, Ben Gurion University and the Bank of Israel. Further thanks goes to Nancy Stockey and Robert King for important comments and tips. Special thanks goes to Dani Tsiddon, Yossi Zeira and an anonymous referee for helpful comments and discussions.
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Gliksberg, B. Monetary policy and multiple equilibria with constrained investment and externalities. Econ Theory 41, 443–463 (2009). https://doi.org/10.1007/s00199-008-0405-1
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DOI: https://doi.org/10.1007/s00199-008-0405-1