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ON INTEREST RATE POLICY AND EQUILIBRIUM STABILITY UNDER INCREASING RETURNS: A NOTE

Published online by Cambridge University Press:  15 September 2009

Kevin X.D. Huang  and
Qinglai Meng
Kevin X.D. Huang
Affiliation:
Vanderbilt University
Qinglai Meng*
Affiliation:
Chinese University of Hong Kong and Oregon State University
*
Address correspondence to: Qinglai Meng, Department of Economics, Chinese University of Hong Kong, Shatin, N.T., Hong Kong; e-mail: meng2000@cuhk.edu.hk.
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Abstract

Bullard and Mitra [Journal of Monetary Economics 49 (2002), 1105–1130] find that, in a New Keynesian economy without capital and under four variants of the Taylor rule, the Taylor principle is sufficient to guarantee both determinacy and E-stability of equilibrium in most cases. Xiao [Macroeconomic Dynamics 12 (2008), 22–49] claims that with capital and mild increasing returns the Taylor principle cannot guarantee either determinacy or E-stability with any of the four rules. In this paper we show that in the Calvo-type sticky price models a second-order condition for profit maximization must be satisfied in firms' pricing decision problem, and we point out that the examples given in Xiao's paper to support his conclusion violate this condition. After imposing this condition, we find that increasing returns have little effect on determinacy and E-stability under two of the policy rules but significant effects under the other two. These results are obtained in models both with and without capital.

Keywords

Increasing ReturnsIndeterminacyE-stabilityTaylor Principle
Type
Notes
Information
Macroeconomic Dynamics , Volume 13 , Issue 4 , September 2009 , pp. 535 - 552
Copyright
Copyright © Cambridge University Press 2009

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References

REFERENCES

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Woodford, M. (2003) Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton, NJ: Princeton University Press.Google Scholar
Xiao, W. (2008) Increasing returns and the design of interest rate rules. Macroeconomic Dynamics 12, 22–49.CrossRefGoogle Scholar