Capital and macroeconomic instability in a discrete-time model with forward-looking interest rate rules

Kevin Huang () and Qinglai Meng

No 07-4, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: The authors establish the necessary and sufficient conditions for local real determinacy in a discrete-time production economy with monopolistic competition and a quadratic price adjustment cost under forward-looking policy rules, for the case where capital is in exogenously fixed supply and the case with endogenous capital accumulation. Using these conditions, they show that (i) indeterminacy is more likely to occur with a greater share of payment to capital in value-added production cost; (ii) indeterminacy can be more or less likely to occur with constant capital than with variable capital; (iii) indeterminacy is more likely to occur when prices are modelled as jump variables than as predetermined variables; (iv) indeterminacy is less likely to occur with a greater degree of steady-state monopolistic distortions; and (v) indeterminacy is less likely to occur with a greater degree of price stickiness or with a higher steady-state inflation rate. In contrast to some existing research, the authors' analysis indicates that capital tends to lead to macroeconomic instability by affecting firms' pricing behavior in product markets rather than households' arbitrage activity in asset markets even under forward-looking policy rules.

Keywords: Capital; Interest rates (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (13)

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Journal Article: Capital and macroeconomic instability in a discrete-time model with forward-looking interest rate rules (2007)
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